The dynamic relationship between foreign direct investment inflows and interest rate in Sri Lanka

Abstract

Foreign direct investment acts as an engine of rapid growth and development of developing and emerging countries. It helps to promote the host nation’s economic growth, financial inflows and markets, technology, and skills. This study aims to identify the dynamic influence and relationship between Foreign Direct Investment (FDI) and interest rate in Sri Lanka over the period 1978 to 2020. Foreign direct investment inflow has been used as the dependent variable while gross domestic products, interest rate, inflation rate, trade openness and exchange rate are the independent variables. This study used the ARDL model for the analysis. According to the bound test, F statistics is greater than the upper bound value. Therefore, this study confirmed that there is a cointegration relationship between foreign direct investment inflows and other explanatory variables. A negative and significant error correction coefficient of FDI inflows reveals that 128% disequilibrium is corrected each year which implies that FDI moves downward towards long-run equilibrium. This study found that there is no substantial relationship between the interest rate and FDI inflows in the long run and a negative and substantial relationship in the short run. Therefore, this study suggests that the government of Sri Lanka has to reflect on developing a monetary policy and maintaining the balance of interest rate and exchange rate. Because of the currency depreciation, the exchange rate negatively influences FDI.