Growth and Investment: Testing for the Relationship for South Asian Countries

Abstract

Last few decades have seen wide-ranging reforms in South Asia. Among the vital industrial reforms is allowing unbridled foreign direct investment (FDI) in many sectors, apart from tariff rationalization and other product market reforms. The outcome of these reforms is increased growth of these countries through direct benefits of FDI and indirectly through crowding in of domestic investment. Fast growth of economies also tends to attract more FDI, as the growing market raises the profitability of the investment. Under this backdrop, this article has two objectives: (a) to see if there is any structural change in the growth of South Asian countries, and (b) what role FDI has played in this structural change. For the first objective, the study employs endogenous ‘structure-break’ tests on annual GDP data for the 58 years from 1960 to 2017 to find the structural change in the economy. For the second objective, we estimate a three-way dynamic causal relationship between investment (FDI and gross fixed capital formation [GFCF]) and growth (GDP) for four key South Asian countries—India, Bangladesh, Sri Lanka and Pakistan. For the analysis, we apply the bounds tests (autoregressive distributed lag [ARDL]) approach to cointegration for the period. The results show different break years for each of the South Asian country. The causal relationship between investment and growth is not uniform for the chosen countries. We find FDI has not resulted in long-term growth in any of the selected countries. Results also show that FDI has not crowded in domestic investment in most of these countries.