Determinants of the Aggregate Inward FDI Flow to Pakistan

Determinants of the Aggregate Inward FDI Flow to PakistanCHAPTER 1INTRODUCTIONOver take inglobalization which gave birth to the concept of interdependence of countries and their economies has been defined as the process by which regional economies, societies, and cultures have become integ regula arised with the assistance of global lucre of sell, communication and transportation. This whollyowed the inductors to invest or transfer their superior where ever they cute which introduced the concept of unlike head up enthronization. Since the recent financial crisis in Asia and Latin America growing as swell up as newly modify countries have been advised to rely mainly on FDI for stinting festering and supplement national savings by superior inflows. Developing countries in break awayicular are in need of investiture funds funds for their development and the coronation total in landing fieldity of cases is bulkyer than the neat intern savey available. Therefore, F DI has emerged as most important source of generating capital compulsory for development of acclivitous countries. Currently Foreign handle Investment has become one of the major(ip) sources of economic development, modernization, employment, income appendage, capital gene symmetryn and a channel for the transfer and gate to advance technologies as well as organizational and managerial skills.Recognizing this fact, developing countries try their train best to lure as much as of FDI as they raft. But attracting FDI is non that much simple, it requires huge efforts on the part of policy makers and authorities.Variety of work outs is considered by an investor before making enthronisation in a particular irrelevant field. Those were labeled as determinants of FDI, and may vary from artless to sphere. Pakistan is currently facing a huge shortf solely of capital to finance its major development projects and to run the organisation operations smoothly.The country requires capital to fulfill the growing needs in defense, bag, education and variety of different aspects of serioussignificance to progress.Since 1990s there has been noteworthy annex in flow of capital investments to developing countries, which motivateddiscussions in literature concerning determinants of such coronation flows.This trend was allow of liberal trade policies, variations in economics relate fundamentals of emergent countries, development of capital markets and transformations in economic conditions around the globe.This seek wallpaper tries to investigate the situation of economic fundamentals in driving enthronement flows.Past search on the economic fundamentals as determinants of distant count enthronization dual-lane economic fundamentals into two broad categories of puff of air factors and carry on factors. Push factors were considered as those economic fundamentals that relateto industrial or developed countries and motivate capital flows,in contrast pull factors exist of economic fundamentals of recipient countries that attract capital flows.One of the major push factors as cited in the past inquiry was kibosh back of the economies of the developed countries (Calvo, 1992 Fernandez-Arias, 1996 Haque, 1997 Montiel and Reinhart, 1999).Pull factors consist of Supply of money and local ingatheringivity of the recipient country (Calvoet al., 1992 Lensink and White, 1998). Calvoet al. (1992)argued that push factors contribute more than pull factors in emergence of capital transfer.Vita and Kyaw (2008) suggested that variations in internalated confess and productivity of the unknown country were main determinants of portfolio and FDI flows.Dunning (1993) by combining prior look on the determinants of FDI came up with OLI? precedent that realmd global manufacturing as function of ownership, localization and internationalization.Variety of theories have been developed regarding the determinants of FDI such as industrial orga nization theory, the pure trade theory, classical theory relating international investiture flows, and locational factor theories.Classical theory relating the international investment flow states that when return on investment crossways countries under autarchy change the investments get out budge from lower to high(prenominal) return providing country. Therefore, this theory assumes outside(prenominal) guide on investment as function of dis similarity of return on investment.Wilhborg (1978)argued that volatility in the exchange array would decrease the come up of portfolio investment and that had withal been well-grounded for FDI(Black, 1977). According to Kohlhagen (1977) the firms that expect devaluation in the currency of exotic country would put back its investment till the time when exporting becomes profi card. Study also cogitate that the higher the exchange respect, the lower the amount of FDI because this phenomena would make exporting relationally less pro fitable.1.2 Problem statementTo detect the best determinants of the aggregate private FDI flow to Pakistan.1.3 HypothesisThis particular research primarily focused on testing the following hypothesisH1 gross domestic product has corroboratory adjoin on FDI.H2 Infra bodily structure disbursement has substantiating mend on FDI.H3 Taxes has interdict extend to on FDI.H4 Inflation has prejudicial push on FDI.H5 GDP per capita suppuration has convinced(p) equal on FDI.H6 flip consider has compulsive affect on FDI.H7 entertain lay has invalidating conflict on FDI.1.4 trace of the StudyThe first chapter of the research focuses on giving basic view of the research and provides information on the overview, issues, purpose and basic theories on the determinants of FDI. In the chapter existing work done by various researchers and past empiric studies have been discussed. The third chapter provides details regarding practical carrying out of the research and describes information collection and analysis procedures. Finally, the remnant chapter gives details regarding the results of the research.1.5 DefinitionsAll the chosenfor predicting FDI were variants that had been used in prior researchand theories relatingFDI.1.5.1 electronic network Foreign Direct Investment (FDI)The net amount of foreign convey investment received by Pakistan measured in current US dollars.1.5.2 Inflation (I)The variable represents yearbook change (%) in the commodities that fall in the category of CPI.1.5.3 evoke reckon (IR)The variable represents the annual rateof interest (%) offered by banks operating in Pakistan on the deposits by customers.1.5.4 supplant rate (ER)Measured as the rateof converting 1 US $ into Pakistani rupees (1 US $ = Rs.).1.5.5 Infrastructure expenditure (IE)Represents the annual amount spent by government on Pakistan on the development of al-Qaida in the country. The variable is measured by annual amount of Public Sector Development pol itical program (PSDP) fund and social unit of measurement was rupees in million.1.5.6 Taxes (T)The variable represents the annual rate of tax (%) applicable on the profits of corporate companies operating in Pakistan.1.5.7 Gross domestic product (GDP)Represents the total tax of sobers and services (at factor cost) produced in Pakistan measured in Rs. Million.1.5.8 GDP per capita growth rate (GDPG)The variable represents the annual rate of growth (%) in the gross domestic product per capita, of Pakistan.CHAPTER 2LITERATURE REVIEWA lot of research has already been conducted in the field of identifying the best determinants of Foreign Direct Investment by various researchers. Most of the research work conducted implies that the determinants of Foreign Direct Investment vary from country to country and from location to location. The purpose of this research is to draw out the violation of Labor cost (Wage), Inflation (I), vex rate (IR), convert rate (ER), Infrastructure expenditu re (IE), Taxes (T), GDP and GDP per capita growth (GDPG) on Foreign Direct Investment (FDI) inflow in Pakistan. The study hypothe size of its positive kindred between GDP, GDP per capita growth, Infrastructure expenditure and exchange rate with FDI whereas Wage, ostentation, Taxes and Interest rate relate negatively with FDI.Pursuing the same objectives Kok and Ersoy (2009) conducted study that do attempt to investigatethe best determinants of FDI in developing countries. Study hypothesized and cerebrate that GDP, inflation, Trade, GDP per capita growth,Gross fixed capital formation and communication (telephone) are positively related with FDI whereas inflation and total debt/ GDP had negative relationship. Barrel and put out (1996) in their empirical studies establish that FDI and both the acceleration and take of gross national product were positively related. In addition unit diligence cost and relative capital cost also had positive relationship with outward-bound str aight off investment. search suggested that in short run funds availability tinges investment timing. Research of Barrel and Pain et al.related to this particular thesis because it tried to identify probable impact of factor prices and demand across countries, as well as exchange rate expectations in determining the total level of foreign direct investment (FDI) by United States companies. According to Janeba (2002) investment cost and government credibility has crucial impact on the level of indwelling foreign direct investment, suggesting that MNCs would pick out to invest in politically stable countries. The research also concluded that when any politically unsteady country has cost advantage over otherwise countries MNC will invest efficient amount in that particular country and will hold excess capacity elsewhere. According to the conventional wisdom lack of perpetration from the government discouraged foreign direct investment in emergent countries.The research work d one by Harvey (1990) focused on the macroeconomic determinants of FDI in addition to variables relating to different industry groups and tried to identify the impact of these variables on the self-whispered FDI flow of the recipient country. Research suggested that switch rate and Sales had significant impact on the foreign direct investment, whereas taxes did not have any significant role in explaining foreign direct investment.Following bit different framework research conducted by Rolfe, Ricks, arrow and McCarthy (1993) made an attempt to check investors investment decision on the understructure of various investment inducements provided by countries in the Caribbean region. The study demonstrated that all inducements do not evenly plea to all investors. The investment characteristics would view which incentives firm manager will prefer. According to the study incentives chosen by firms exporting their productsvary from those firms that sale product in local markets, compan iesopening operations in a new state had different inducement preferences than firms involved in growing or purchasingprevailing operations, incentive choicesoccasionally differ by state of investment, incentives varyreliant upon the products made, handsome financiersselect different motivations than those preferred by smaller companies and incentive inclinations can waffle on yearly basis. In short the research concluded that incentive preferences can be represented as a function of the investment type, countries involved, the market positioning of the investing companies, type of products produced by the investing company, amount of the capital invested, and investment time.Terpstra and Yu (1988) tried to examine the impact of firm-specific advantages and locational factors on the foreign investment made by advertising agencies of U.S. Study focused ondetermining role of market size of recipient country, geographic nearness of recipient country, size of the investing firm, exper ience of investing firm in international operations, oligopolistic rejoinder and existence of basismade country clientelesoverseason FDI. The research depicted that U.S. advertising agencies prefer to invest in those foreign countries having large market size, did not discriminated countries on the basis of their geographic location, inclined to enter foreign market with bigger firm size, tended international expansion with increasing understanding of international operations, reacted oligopolistically season making foreign investment and followed client firms belonging to home country epoch going abroad. Additionally research establish that oligopolistic reaction had stronger impact in 1984 compared to 1972, intensity of competition had significant impact on oligopolistic reaction and top agencies witnessed stronger impact of oligopolistic reaction.Another study tried to examine determinants of FDI by using macroeconomic variables but more emphasis was given to various ratios relating to capital and labor, it also used The Heckscher-Ohlin Theory? which stated that a country exports those commodities that intensively use the countrys relatively abundant factors and imports those goods using its scarce factors intensively. Results indicated that countries wish U.S. imported goods whose production required higher capital to labor ratio than the goods exported and when the endowment ratio of capital/labor developmentd the ratio of capital for each prole in import-competing production to capital for each worker in export production declined.Gopinath and Echeverria (2004) studied the association between foreign investment (FDI) and trade in mutualframework, that is, source or investing countrys exports and foreign investment toinvestment recipient country wereexaminedthrough gravity- shape methodology. Results suggested that physical distance had negative impact on trade-FDI ratio, this caused nations to switch from export to FDI based manufacturing. Resea rch also represent GDP per capita to affect trade-FDI ratio positively and institutional quality strongly encouraged FDI, additionally FDI was also encouraged by regional trading agreements.The empirical study conducted by Goldberg and Kolstad (1995) stated that exchange rate dissymmetry contributed to production internationalization without depressing economic natural process in the home country. Furthermore, exchange rate instability motivated the portion of investment activity situatedin foreign state. Research also suggested that exchange rate instability did not have statistically dissimilar personal effects on capital investment regions when distinguished between varieties of periods where real or financialvariations dictated exchange rate movement.Yin (1999) made an attempt to study the impact of tax inducements on the show of a localbusinesswith respect to price, productivity, revenue, and entrance/exit, by winning into consideration technology relocation through FDI . The study concluded that if thehost countrys government providedhigher tax relief to foreign companies, this will result in rise in total yield and decrease price index which will encourage more foreign businesses to move in the industry while certain present host businesses will need to departure. Research also suggested that government should be cautious in decreasing rate of taxes to attract FDI.Vita and Kyaw (2008) used empirically controllable structural VAR model for identifyingdetermining factors of investment flows and variance decomposition and impulse response analyses to examine the time-based dynamic effects of variations in both pull andpushmotivators on FDI and portfolio investments. Study suggested that variation in real variables representing economic activity for example domestic productivity and foreign output possess more violence in explaining variation in investment flows to developing nations. This research developed structural VAR model to test relative im portance of the determinants of disaggregated investment flows to developing countries. The study investigated the horizontal surface to which deviations in FDI and portfolio investmentswere caused by variety of pull andpush factors throughvariousperiod horizons.Studying the impact of FDI on variousfacets of local economies, containingglobal trade, employment, gross fixed capital formation, output, balance of payments(BoP) and overall welfareHejazi and Pauly (2003) found that FDI was encouraged by market access and factor price differences, and on the role of intra-firm trade. According to the research prediction of whether growth in outward FDI will increase or decrease domestic GFCF is not achievable. Therefore, comparisons of such growth relative to growth in innermost FDI can be a misleading indicator for policy makers. Since the impact of FDI on domestic GFCF depends on the underlying motivation for investment, and not simply on the growth in outward relative to in FDI, the results are of interest to all countries. The implication of results stated that quickprogress in outward foreign direct investment, proportional to inward progress, should not be taken as a negative growth, butmightbe source of success.Chen (1996) suggested that capacity of the market share to expand touch inward flow ofFDI but labor cost (WAGE) does not affect FDI. Similarly foreign investing companies had utilized the natural and energy resources of horse opera regiondespite of low allocative efficiency in this area.Interregionalrailwaynetworksweresignificant in location preference of foreign investors. Besides that, foreign investors were reluctant in locating near state-of-the-artlocal Chinese businesses in the eastern as well as middle provinces. These results were significant because the choice of FDI location appeared to have been motivated by the presence of good transportconnections, high-tech filtering and, to some level by the capacity of the market share to expand. The choice of FDI location did not appear to have been persuaded by taking into accountlabor cost variances.According to the neoclassical model of growth, growth rate of labor as well as technological developmentwere considered as exogenous and inward Foreign Direct Investment (FDI) will lead to increase in the investment rate and which will ultimately lead to increase in the growth of per capita income but the growth effect will not last in the long run (Hsiao and Hsiao, 2006). Papanek (1973) indicatedstatistically significant negative effect of varioussorts of investment on domestic savings. Grounded on a sample of 85emerging countries, researchconcluded that foreign investment displaced national savings. Precisely, the research exhibited all types of foreign investment either in shape of aid or separate investment compressed the domestic savings. As a result the economy of the FDI recipient country went into state ofhigher dependency on foreign investment for development.The emp irical studies of Cushman (1985) based U.S. isobilateral FDI outflow and inflow data concluded that exchange rate variability had positive relation with set of flows.Connor (1983) conducted research which focused on inward as well as outward flow of FDI. The study divided country specific advantages into three categories FDI Probability, FDI Propensity and FDI Penetration and their impact on FDI.Larudeeand Koechlin (1999) research focused on the wages or labor costs and productivity in terms of production costs as the determinants of FDI. This research usedsweatshop labor argument that relied indirectly on assumption of simplistic trade model that assumed all of the national firms to have access to similar technology. But in contrary MNE and abundant theory acquire higher labor efficiency due to the firm related advantages MNE possess. Thediscrepancy between investing and recipient country in average manufacturing wage should therefore be an in capable determinant of FDI flows.CHAP TER 3PROPOSED METHODOLOGY3.1 Method of Data assemblyThe secondary data necessarily required to perform the research was garner from the official sites of The World till and The State Bank of Pakistan. Additionally, some of the required data was abstracted from the book statistical Supplement and Yearly hold back both being published under the supervision of State Bank of Pakistan.3.2 Sample SizeThe data used for the purpose of research consisted of 30 years annual data of the variables used in research. Data of all the variables belonged to period starting from fiscal year 1980 to fiscal year 2010.3.4 Research Model developedIn order to test the hypothesis of the research multiple regression model was developed. The model established is similar to the research model used by Kyrkilis and Pantelidis (2003).FDI= + 0GDP + 1GDPG 2Wage- 3I + 4ER + 5IE 6T 7IR + WhereFDI = Net amount of Foreign Direct Investment received by PakistanWage = Annual wages gainful to a worker (Labor cos t)I = Inflation,IR = Interest rate, ER = Exchange rate, IE = Infrastructure expenditure,T = Taxes, GDP = Gross domestic product,GDPG = GDP per capita growth rate.3.3 Statistical TechniqueIn order to test the hypothesis developed of the research the statistical technique of multiple regressionanalysis was applied. This technique was applied because both the dependent variable and autarkic variables were scale and under this situation the prediction power of regression analysis is stronger as compared with the other statistical techniques available.CHAPTER 4RESULTS4.1 Findings and variant of the resultsThe results drawn by applying Multiple Regression analysis were as follows disconcert 4.1 Model add upmaryModelRR Square correct R SquareStd.Errorof the EstimateDurbin-Watson1.998a.996.9956.65146E172.744The model summary table explains what amount of variance in the dependent variable is explained by the independent variables. The value of R-square is .996 which means that approximat ely 99.6 % of the variance of SQFDI is accounted for by the model and only .04 % of the variance remains unexplained. Independent variables were square of Infrastructure Expenditure (PSDP Fund), Interest Rate (IR), Inflation (I) and Exchange Rate (ER) and the dependent variablewas Square of Net Foreign Direct Investment (SQFDI).Table 4.2 ANOVAModelSum of SquaresdfMean SquareFSig.1Regression2.524E3946.310E381426.142.000a proportionality1.106E37254.424E35Total2.535E3929The analysis of variance table explains the model fit, sig. value of .000 suggests F-test to be significant, and therefore the model is statistically significant. When the sig. value in the Anova table is less than .05 the model fit is good and regression can be applied on the data.Table 4.3 CoefficientsModelUnstandardized CoefficientsStandardized CoefficientstSig.Collinearity StatisticsBStd. ErrorBetaToleranceVIF1(Constant)-9.595E177.703E17-1.246.224Inflation-8.806E163.960E16-.037-2.224.035.6401.562Interest Rate2.047E1 76.261E16.0453.270.003.9201.086Exchange rate-5.646E169.021E15-.125-6.259.000.4402.273IE1.654E83349513.6191.09449.392.000.3562.809The co-efficients table shows the significance of individual independent variable in explaining the dependent variable. In the final model square of Infrastructure Expenditure (PSDP Fund), Interest Rate (IR), Inflation (I) and Exchange Rate (ER) were the statistically significant variables.The effect of Inflation (Standardized B= -.037, P =.035) is statistically significant havingnegative coefficientdemonstrating that largerthe value of inflation rate, the lower the Foreign Direct Investment. The value of beta indicates that 1 unit increase in inflation will decrease FDI by .037units. Similarly, the effect of Interest Rate (Standardized B= .045, P =.003) is significant and its coefficient is positive indicating that the greater the value of interest rate, the higher the amount of FDI received. The value of beta indicates that 1 unit increase in interest ra te will increase FDI by .045units. Next, the effect of Exchange Rate (Standardized B= -.125, P =.000) is statistically significant havingnegative coefficientdemonstrating that larger the value of exchange rate, the lower the amount of FDI. The value of beta indicates that 1 unit increase in exchange rate will decrease FDI by .125units. Finally, the effect of Infrastructure Expenditure (Standardized B= 1.094, P =.000) is also statisticallysignificant having positive coefficient indicating that the greater the amount spent by government as infrastructure expenditure, the higher the amount of FDIreceived. The value of beta indicates that 1 unit increase in amount of infrastructure expenditure will lead to an increase of 1.094 units in FDI.Empirical Model DevelopedFDI = 1.094 InfrastructureExpenditure + .045 Interest Rate .125 Exchange Rate .037 Inflation4.2 Hypothesis Assessment SummaryHypothesisSig.E.CH1 GDP has positive impact on FDI.089.560 eliminateH2 Infrastructure expenditure ha s positive impact on FDI1.094.000AcceptH3 Taxes has negative impact on FDIRejectH4 Inflation has negative impact on FDI-.037.035AcceptH5GDP per capita growth has positive impact on FDI.001.962RejectH6 Exchange rate has positive impact on FDI-.125.000RejectH7 Interest rate has negative impact on FDI.045.003RejectCHAPTER 5DISCUSSION, CONCLUSION, IMPLICATIONS AND FUTURE RESEARCH5.1 ConclusionForeign direct invest being the most important factor in the development of developing countries likewise Pakistan. From recent years there has been great fight going on among LDCs from all over the serviceman to attract higher amount of FDI to fuel their economic growth. This research was think to find out the impact of macroeconomic variables including GDP, GDP per capita growth rate, Interest rate, Inflation rate, Wage rate, Exchange rate, Tax rate and Infrastructure expenditure (PSDP fund) on the inflow of Foreign Direct Investment in Pakistan.The relationship between labor cost (Wage) and FD I could not be established because shy(predicate) data was available on the annual wage rate in the country. GDP, GDP per capita growth rate and Tax rate were statistically unnoticeable in contributing in the final model.The most significant variables in the model were Inflation rate and Exchange rate both had negative relation with FDI inflow having beta of -8.806 and-5.646 respectively.Interest rate and Infrastructure expenditure (PSDP fund) were positively related with FDI inflow having beta of 2.047 and 1.654 respectively.5.2 DiscussionAccordingto results derived from the research inflation had negative impact on FDI as found by (Kok and Erosy, 2003). Contradictory to the studies of Kok and Erosyet al. andAsiedu (2002) that found positive impact of GDP per capita growth rate on inward flow of FDI but in case of Pakistan GDP per capita growth rate proved insignificant.Results regarding the impact ofinfrastructure on FDI were similar to those established by Asiedu (2002)but the impact of tax rate was conflicting. The results regarding the impact of exchange rate on FDI were consonant with those found by (Cushman,1985).Terpstra and Yu (1988) and Weinstein (1977) found positiveimpact of GDP on FDI but correspond to the results of this study GDP was statistically insignificant in explaining variation in FDI.Finally, the results regarding the impact of interest rate on FDI were consistent with those found by (Fernandez-Arias, 1996).5.3 Implications and RecommendationsPakistan belongs to category of countries those currently face huge deficit of resources to finance its major growth projects and to manage the government operations smoothly.This research paper made attempt to explore those factors that in particular have direct impact on the inward FDI flow of the country.Results of the research show that exchange rate and inflation were negatively related with FDI and had statistically significant impact on the FDI received by the country. Therefore, the gove rnment of Pakistan should try to control the rate of inflation and fluctuations in the exchange rate and keep it at minimum possible level inorder to assist the increase in inflow flow of FDI.Similarly, infrastructure expenditure and interest rate were found to be positively related with inflow of FDI, keeping this in mind government should increase its outgo on the development of infrastructure within the country. Following these strategies the government would be able to attract higher amount of FDI.5.4 Future Research in general speaking determinants of foreign direct investment could consist of variety of factors other than some macroeconomic variables discussed in this particular research paper. The most habitual of those that previously have been studied were political factors including political stability, level of corruption, structure of the industry, market openness and variety of other factors impact the foreign direct investment received by any specific country. But p ublic lecture in the Asian scenario cheap labor has been one of the major determinants of the inward FDI flow but unfortunately data regarding labor cost (wage) could not be collected and the impact of labor cost on FDI in case of Pakistan remained unidentified. Therefore, great deal of research could be done in order to identify those variables that have an impact on FDI.