Abstract
The present tests the causal interactions between foreign direct investment (FDI) and banking intermediation in China, the results showed that real interest rates Granger-caused FDI inflows, while the latter led service sector's value added. Interestingly, interest rate spread and FDI mutually influenced each other. Contrary to conventional wisdom, FDI inflows have been found to be more influenced by opportunity costs in the banking sector (interest rate structure). The results suggest that growing FDI inflows in China might have contributed in hindering the development of banking intermediation. Eventually, this finding spotlights the need for liberalisation of the entire interest rate and recomposition of capital inflows.
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