Determinants of Foreign Direct Investment Inflow to Ethiopia: Time Series Evidence (ARDL Approach)

Abstract

In low income country foreign direct investment is taken as the next best alternative source to fill the gap between domestic savings and the required investment for economic growth. While its inflows to Ethiopia are the lowest by a wide margin both in actual quantity and as a proportion of gross national product (GNP). This study deals the empirical relation between FDI inflow and its determinants in Ethiopia by employing Autoregressive distributed lag model for the time period covering from 1981 to 2018. The stationarity properties of the data was detected using Augmented Dickey–Fuller (ADF) and Phillip–Perron (PP) unit root test and the result indicates all the variables are stationary at level and first difference calling the effectiveness of ARDL model. The ARDL bound test used to test the existence of long-run link among the variables and the result confirmed that there is long run relationship among FDI and independent variables. The results indicated that the FDI flows to Ethiopian economy are determined by the degree of trade openness; domestic market size proxied by per capita GDP; domestic bank credit; rate of inflation; human capital and official exchange rate in the long-run and trade openness; rate of inflation and official exchange rate in its short run dynamics. The policy which creates favorable environments for domestic credit institution; predictable official exchange market and uninflated domestic price situation enables to harvest the highest possible expected benefits from FDI inflow. Keywords: FDI, ARDL, Bound test, ECM, Ethiopia DOI: 10.7176/IAGS/85-01 Publication date: August 31 st 2020