Relationship Between Foreign Direct Investment and Financial Development

Abstract

Foreign direct investment exerts a positive effect on economic growth only if a country has a well-functioning financial system. Thus, the objective of this paper is to examine the relationship between foreign direct investment and financial development in five selected ASEAN countries such as Malaysia, Indonesia, Singapore, Thailand, and the Philippines. The Pedroni panel cointegration test is conducted to ascertain the presence of long-run relationship between foreign direct investment and financial development. The results obtained demonstrate that there is indeed a long-run relationship between the variables. The causality tests employed by the study found several interesting outcomes. First, there is no causal relationship between foreign direct investment and domestic credit by banking sector, but there is a unidirectional causal relationship between foreign direct investment and domestic credit to private sector. Second, there exists a unidirectional causal relationship between market capitalization value and foreign direct investment, but a bidirectional causal relationship between foreign direct investment and stock value traded. Policy makers are recommended to improve the quality of financial system so that the ASEAN countries could enjoy the maximum benefits of foreign direct investment.