Literature Review And Theory On Domestic Investment Finance Essay

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This chapter will discuss details on the literature review that can be related with the study conducted. It will review the variables one by one and the variables that will discuss are DDI, DCPS, CPBS, GDS, GDP per capita, GDP deflator, M3, an also the INT. This section also covers the theory associated with the study.

Theories Associated With This Study

The theory related with the study is about the data and also the model adopted when conducts the study. In order to examine the determinants of domestic investment in Malaysia and its relationship, time series data were used. The data from year 1980 until 2008 is taken. The model adopted in this study is the regression models such as the Unit Root Test, Ordinary Least Square method and also the Granger Causality Test. Unit rot test is using the Augmented Dickey-Fuller test to measure the stationary level of the data. Ordinary least square method is using the multiple regressions to measure the correlation between variables and the Granger causality test using Pairwise to determine who lead to whom. The statistical software, which is E-view and Microsoft Excel were used to test the data to gain the result.

Literature Review

Other than the foreign direct investment, the domestic direct investment also contributes to the economic growth in Malaysia. There are so many factors that can determine the domestic direct investment that can lead to economic growth in a country. The determinants are like domestic credit to private sector, total liquidity liability of financial intermediaries as a proxy of M3, domestic credit provided by bank, gross domestic product per capita, growth rate of gross domestic product deflator, gross domestic saving, and interest rate charge on loans by using the lending rate.

Actually, these factor determinants domestic direct investments can be divided into two groups as stated by Ndikumana, L. (2000) in his paper financial determinants of domestic investment in Sub-Saharan Africa: evidence from panel data, which is financial determinants and the macroeconomic determinants. The three factor which are domestic credit to private sector, total liquidity liability of financial intermediaries (M3), and the credit provided by banks fall under financial determinants, while the other factor fall under the macroeconomic determinant.

Term of variables

Credit provided by bank sectors

Credit provided by bank sector is one of the variables that contribute to domestic direct investment. It is based on the percentage of gross domestic product (GDP). By definition from the World Bank (WDI), credit provided by bank sectors (%GDP) involve and provide all types of credit in term of gross basis to various instrument or sector in Malaysia with the credit exception on government. Together with the banking sector is the financial power and the funds deposit banks and also the other types of banking institution which subject to obligation such as saving deposit, mortgage loan union and building and also credit union. According to the World Bank, it is reported that the credit provided by bank sector in 2008 is at 115.22.

Domestic credit to private sector

According to the World Bank, credit to private sector means the funding available to private sector. For example, make loan, buy the non-equity securities, and also the trade credit and other loans which makes claim for payment. In some countries the claim will involve the credit to public enterprise and in certain cases, credit to state-owned or partially state-owned also included. It is recorded in the World Bank that the Malaysia's domestic credit to private sector is at 100.57 during 2008.

Total liquidity liabilities of the financial intermediaries

Total liquidity liabilities of financial system means the ability of the financial system to converted their assets or any item that have an economic value, into cash in hand quickly. In this study, a total liquidity liability of financial intermediaries is as a proxy of M3. Financial intermediaries move the investment capital to meet higher return on investment. It is also efficient to transform the asset into liquid term. Besides that, financial intermediaries also can get rid of the liquidity risk of the assets and liabilities.

Interest rate charge by bank on loans

Interest rate by definition is the fee paid by the borrower on the amount owed. Interest rate charge by banks on loans also contributes to the domestic investment in Malaysia. When borrowed money, there is an interest paid by borrowers to the lenders as the percentages of the amount borrowed. The interest rate paid is based on the amount borrowed and the period of borrowing made.


Inflation also can contribute to the domestic direct investment in a country. Inflation can be measure by using the growth rate of the GDP deflator. Inflation by definition from the Investopedia News and Articles is the increasing of the goods and services' price general level while the purchasing power falls. In Malaysia, it was recorded in the World Bank that the inflation rate is at 2.9 percent in February 2011. There is an increasing in the rate where the inflation rate during 2005 until 2010 was 2.77.

Gross domestic product per capita

Gross domestic products per capita is an estimation of the goods value produced in country per person, meet the GDP of the country which divided by the number of people in that country. According to the World Bank, the GDP per capita for Malaysia was recorded at 5151 US dollars in December 2008. But during year 1960 until 2008, it was reported that the GDP per capita for Malaysia was at 2448.94 US dollars.

Gross domestic saving

According to Index Mundi, gross domestic saving (%GDP) is the calculated value of the GDP less the total consumption made by a person. Saving means put aside half of the income for use in the future. For example, they can make bank deposits or buy securities. Saving is important to sustain our economic growth because of the relationship with investment.

Review of recent study on variable under study

Credit provided by bank sector

Credit provided by bank sector can encourage people to make an investment activity locally that can contribute to our economic growth in the short-term and the long-term. The financial determinants with the "credit" statement is said to be the most important determinants on investment [Schumpeter (1932), Keynes, 1937, 1973]. This idea is supported by Gurley and Shaw (1955). They relate the financial development with the economic growth for a country. Fisher (1933) also state that the poorly financial market performance can result in economic downturn. When the demand on government credit is crowd out and it is hazardous to make loan in long-term, it is hard for the banks in less developed country to proper prepared the funds to the firm in the country. According to Atkin and Glen (1992), the firms in developed country will make fund internally and vise versa for the less develop countries.

Domestic credit to private sector

It is the funding provided to private sector. They can make loan, buy government security, invests money or their assets in bank or other institutions. It is one of the investment activities. Based on the Serven and Solimano (1993) equation on investment, credit to private sector is the crucial factors that can determine the rate of investment in a country. It is because, when the interest rate is low, people will choose not to put their money in bank for saving purposes, and it is therefore hard to facilitate fund for the investment project which is profitable. The allocation of credit to the private sector is mutually related with the investment (King and Levine (1993)). It is supported by Serven (1998) that it is also (the credit shares) strongly determine the investment make by private sector in the 60 less develop countries. Besides that, the availability of credit as highlighted by Vogel and Buser (1976), Fry (1980), Tun Wai and Wong (1982), Blejer and Khan (1984), Gupta (1984), Garcia (1987), Leff and Sato (1988)), and Oshikoya (1994) also determine the private investment.

Total liquidity liability of financial intermediaries

The bank's liabilities liquidity which is using M3 determines the financial sector's size. This measurement is used in previous study by King and Levine (1993) and also Levine and Renelt (1992). Fisher (1933), state that the poorly financial market performance can result in economic downturn. Financial intermediary is also one of the important factors under the financial determinants. The financial intermediaries give better liquidity to the savers at the same time reduces the liquidity risk [Levine, 1997; Pagano, 1993; Gertler, 1988]. Liquidity is the ability of asset to be converted into money or cash. When people want to invest, they need to make sure that their investment has high liquidity.Ash Demirgiic-Kunt and Ross Levine (1996) stated in their paper about Stock Market Development and Financial Intermediaries: Stylized Facts, the more developed the market stock of a country, the better it is their financial intermediaries. Based on the theory, the market that has high liquid would help to improve the capital allocation for long-term growth and also to develop the stock market.

Interest rate charged by banks on loans

When people make loans or borrow money from any financial institution, they will be charge in term of percentage which called interest rates on the amount borrowed. For small country, they will accept the world given interest rate but the large country interest rates will be affected when the savings and investment is altered (Obstfeld, 1986; Summers, 1988; Frankel, 1992). The investment will increase if the savings increase and the interest rate is low.


All the government aims to lower their level of inflation. Inflation rate is a measure on how well the government handles their economy. According to Levine and Renelt (1992), the countries that highly growth is the countries with lower inflation rate.

Gross domestic product per capita

Gross domestic product is a measurement of the economic growth. It is use to determine the economic condition of a country. According to Fielding, 1997, 1993; Greene & Villanueva, 1991; Wai & Wong, 1982, the investment rate is high when the output growth is also high. Fischer (1991) said that the growth per capita will negatively affected by the inflation.

Gross domestic saving

For the gross domestic saving relationship with the domestic investment, Bayoumi (1990); Dooley, Frankel & Mathieson (1987); Feldstein & Horioka (1980) found there is positive relationship between saving and investment. The lower the domestic saving, the lower will be the domestic investment in a country. But it is argue by James E.P (2005) which is found the negative coefficient with the investment. Dooley, et. Al (1987) and Jansen and Schulze (1996), also study on the saving-investment relationship and they found that the saving and investment is negatively correlated in short-term period.