Empirical Analysis of Macroeconomic Indicators as Determinants of Foreign Direct Investment in Pakistan

Abstract

The aim of the study is to analyze and evaluate the impact of core macroeconomic variables – GDP, Inflation and Exchange Rate on Foreign Direct Investment (FDI) inflows in Pakistan. The role and effect of these macroeconomic variables on the growth of FDI inflows has always been the major area of interest for the economics and finance experts and policy makers of the present era. The study therefore attempts to explore how the core macroeconomic indicators affect the FDI inflows in Pakistan. For this purpose time series data covering four decades from year 1971 to year 2009 has been taken for analysis. The data is taken from online material available at websites of World Development Indicators, International Monetary Fund, State Bank of Pakistan and Economic Survey of Pakistan. Descriptive and inferential statistical analyses are performed to evaluate the data and generalize the results. Pearson Correlation, Augmented Dickey Fuller Unit Root Test, Phillip Peron Unit Root Test, Johnson Co integration Test and Ordinary Least Square technique is used to analyze and conclude the results. The results showed that all three macroeconomic variables are positively associated to the dependent variable – FDI. Data stationarity is confirmed through Phillip Peron test at first difference. Data co integration is checked through Log likelihood Ratio that satisfied co integrating equation at 5% significance level. The assumption used in this co integration test is intercept with no trend and vector auto regressive with linear deterministic trend. OLS technique is used to measure the strength and significance of explanatory variables against dependent variable. The results show that GDP, inflation and exchange rate have positive impact on FDI inflows, and the model is found to be significant at 1% level, hence it is concluded that any increase in the three explanatory variables would cause an increase in FDI, therefore government should focus on stabilizing these variables to attract more FDI in to the country to support the economic growth of the country.