External Debt and Domestic Investment in Pakistan: A Cointegration Analysis

Abstract

The present study explores the impacts of foreign capital inflows in terms of external debt, foreign direct investment and worker’s remittances on domestic investment in Pakistan economy for the period of 1972-2007. Since the study utilizes the time series data of the sample period so augmented Dickey-Fuller unit root test has been employed to find out each of the time series variables to be stationary at their first difference. The Johansen cointegration confirms two cointegrating vectors and all of explanatory variables show positive and significant impact on domestic investment in long run. The Granger causality test results, based on the VECM, confirm long run and short run causality from external debt, foreign direct invest and worker’s remittances to domestic investment. The diagnostic and stability tests conclude the model to be valid and stable. The study also provides some policy recommendations.