Relationship between Foreign Direct Investment & Financial Market Development - Evidence from South Asian Markets

Abstract

This study examines the relationship between FDI and financial market development (FMD) in the existence of other aspects, i.e., governance, social, and macroeconomic variables. The study uses the annual panel data of four emerging South Asian countries, i.e., Bangladesh, India, Pakistan, and Sri Lanka, from 1994 to 2016. Panel ARDL model is used to examine the long run and short-run relationship, while correlation and causality analysis is used to examine the relationship between FDI and FMD variables. Results show that exchange rate, governance, inflation, and real GDP growth rate are the significant predictors of FDI in South Asian countries, while FDI, education, real GDP growth rate, balance, exchange rate, and inflation are the main determinants of FMD. A positive correlation exists between FDI and FMD variables. However, bi-directional causality exists between CREDIT and FDIGDP, while no causality exists between CCB and FDIGDP; however, one-way causality exists from STKMKRTCAP and STKVOLTRA to FDIGDP. Our study suggests that countries having better governance have an edge in attracting FDI to the country. However, we have not been able to exploit the benefits, and the policymakers need to devise appropriate policies to attract FDI in South Asian countries.