Faiza Saleem(Corresponding author) Lecturer - Department of Management Sciences, University of Wah. The Mall, Quaid Avenue, Wah Cantt (47040) Pakistan

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1 IMPACT OF INFLATION AND ECONOMIC GROWTH ON FOREIGN DIRECT INVESTMENT: EVIDENCE FROM PAKISTAN Faiza Saleem(Corresponding author) Lecturer - Department of Management Sciences, University of Wah Anish Zahid BBA Student - Department of Management Sciences, University of Wah Bisma Shoaib BBA Student - Department of Management Sciences, University of Wah Madiha Mahmood BBA Student - Department of Management Sciences, University of Wah Sadaf Nayab BBA Student - Department of Management Sciences, University of Wah Abstract This paper investigates the impact on foreign direct investment due to the growth and inflation of a country. Secondary data has been gathered from the websites of ADB and SBP during the time period of 1990 to 2011 for this purpose. In this paper, three variables are used FDI, GDP, INF. FDI is taken as dependent variable whereas GDP and INF are taken as independent variables.to assess the impact of FDI on growth and inflation time series data regression has been used.the result suggests that there is a positive relationship exists between foreign direct investment (FDI) and inflation and there exist a negative relationship between gross domestic product (GDP) and foreign direct investment (FDI). KEYWORDS: GROSS DOMESTIC PRODUCT, FOREIGN DIRECT INVESTMENT, INFLATION. 1. Introduction and Literature Review There are number of definitions of FDI, GDP and INF presented by various authors. Starting with the definition of FDI, IMF defines FDI as The acquisition of at least ten percent of the ordinary shares or voting power in a public or private enterprise by nonresident investors. Direct investment involves a lasting interest in the management of an enterprise and includes reinvestment of profits. In simple words FDI is the foreign investment in the host country. FDI is basically divide into two types inward FDI and outward FDI or net FDI is the combination of inflow FDI and COPY RIGHT 2013 Institute of Interdisciplinary Business Research 236

2 outflow FDI. Inward foreign direct investment means inflow of investment in your country and outward foreign direct investment means the flying of local capital towards foreign countries. (Dr.Niazi et al 2011) define Inflation, as this term was always used everywhere and especially in this country, it is defined as increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But most of the citizens today use the term `inflation' to refer to the phenomenon that is an certain outcome of inflation, that is the tendency of all prices and wage rates to rise. And GDP is defined as the The Gross Domestic Product is the market value of all final goods and services produced within a geographical entity within a given period of time "Gross" because the depreciation of the value of capital used in the production of goods and services has not been deducted from the total value of GDP; "Domestic" because it relates only to activities within a domestic economy regardless of ownership (alternatively: "national" if based on nationality); "Product" refers to what is being produced, i.e. the goods and services, otherwise known as the output of the economy. This product/output is the end result of the economic activities within an economy. The GDP is the value of this output. Value is made up of prices and quantity. An economy can increase the value of its GDP either by increasing the price that will be paid (e.g. by raising quality) for its goods and services, or by increasing the amount of goods or services that it produces. In order to avoid double-counting, it is important that GDP measures each product or service only once, i.e. the "final value". So, Gross Domestic Product is the crossing point of three sides of the economy: demand, production and income. (Yanne Goossens 2007). Ekpo, A.H. (1995) examined that the factors like higher profit from investment, low labor and production cost, political stability, enduring investment climate, functional infrastructure facilities and constructive regulatory atmosphere also help to attract and preserve FDI in the host country.chadee and Schlichting (1997) examined some of the aspects of FDI in the Asian-Pacific region. He found that FDI has a positive impact on the economies of all that regions. Borensztein, etal., (1998) found that FDI is an essential medium for the shift of technology, contributing comparatively extra to growth than domestic investment. Though, the superior productivity of FDI holds only when there is minimum threshold stock of human capital exists in the host country. Hence, FDI is beneficial for the host country s economic growth only if there is adequate absorptive capability of the sophisticated technologies is existing in the host economy.the World Investment Report UNCTAD (1999) also identifies some econometric models to formative the impact of FDI on growth.alfaro et al (2000) examined the FDI and Economic Growth. They found that FDI increases economic growth in economies with positively developed financial markets. Nair-Reichert and Weinhold (2001) found that a contributory linkage exist between FDI and growth. They applied mixed fixed and random estimation to scrutinizethe relationship between FDI and growth in developing countries.ram and Zhang (2002) also examined Foreign Direct Investment and Economic Growth. They support the notion that FDI promotes economic growth in the way that FDI is the source which transfers the advanced manufacturing technologies from the DCs (Developed countries) to the LDCs(less Developed countries). They also said that FDI improves the foreign exchange reserves of the host country. Chakraborty and Basu (2002) examined foreign direct investment and growth in India. They apply the procedure of co -integration and error- correction modeling to inspect the linkage between FDI and economic growth in India. Their results recommend that GDP in India is not Granger cause by FDI, and the causality runs additional from GDP to FDI.Choe (2003) examined the promotion of economic growth due to FDI and GDP. They collect the data from 80 countries during the period of They perceive two-way causation between FDI and growth, but the effects are more visible from growth to FDI. Hsiao and Shen (2003) examined the Foreign Direct Investment and Economic Growth. They found the two way relationship between FDI and growth and support feedback relationship between FDI and GDP.Li and Liu (2004) COPY RIGHT 2013 Institute of Interdisciplinary Business Research 237

3 examined Foreign Direct Investment and Economic Growth. For that they collect the data from 84 countries during the period of 1970 to They found that a strong positive relationship exist between FDI and GDP especially since the decade of 1980 s.chowdhury and Mavrotas (2005) analyzed the fundamental relationship between FDI and economic growth for three developing countries, which are Chile, Malaysia and Thailand. According to them, GDP is the factor that affects FDI in the case of Chile, whereas in the case of Malaysia and Thailand, there is a strong confirmation of a bi-directional causality between foreign direct investment and GDP. Hansen and Rand (2006) examined the Causal Links between FDI and Growth in Developing Countries. They found that FDI increases economic growth of any country but if the country has good trade policies, labor force skills and absorptive capabilities then the country is able to get benefit from FDI.Baharumshah and Thanoon (2006) examined the foreign capital flows and economic growth in East Asian countries. They use dynamic panel models to demonstrate the optimistic involvement of FDI on the growth process of East Asian economies. Duasa (2007), examined the Malaysian Foreign Direct Investment and Growth.According to them there is no strong evidence of causal relationship between FDI and economic growth exists. This shows that, in the case of Malaysia FDI does not effect economic growth, but FDI involves in the stability of growth as the growth contributes to stability of FDI.Jyun-Yi, Wu and Hsu Chin-Chiang (2008) examined the promotion of economic growth due to foreign direct investment. They collect the data from 62 countries over the period of 1995 to They concluded their study as if the host countries have superior level of initial GDP and human capital than FDI have activist impact on growth for those countries. Chakrabory and Nunnenkamp (2008) examined Economic Reforms, FDI, and Economic Growth in India. They viewed sectoral growth impact of FDI in the sectors of India and analyzed that FDI in the service sector of India causes the promotion of growth in the manufacturing sector through cross-sector spillovers and hence in the economic growth. Karimi and Yusop (2009) examined the FDI and Economic Growth in Malaysia. They run OLS regression on the data gathered from 45 countries. They found that FDI is a factor that due to which economic growth of a country increases.nuzhat Falki (2009) examined the Impact of Foreign Direct Investment on Economic Growth in Pakistan. She concluded her study as there is statistically negative relationship exist between FDI inflow and GDP.Anokye M.Adam & George Tweneboah (2009) examined the Foreign Direct Investment and Stock Market Development from Ghana s perspective. They apply multivariate co-integration analysis Vector Error Correction Model (VECM) on their collected data over the period of 1991 to They found that FDI plays an important role in the development of Ghana stock market and a long run relationship exists between FDI and nominal exchange rate. Wijeweera et al (2010) examined the Economic Growth and FDI Inflows. They use the data from 45 countries during the period 1997 to They found number of factors that ensure. Muhammad Zahid Awan, Bakhtiar Khan, Khair uz Zaman (2010) examined A Nexus between Foreign Direct Investment & Pakistan s Economy. They found that there is no significant impact of debt servicing and GDP on FDI inflows in the perspective of Pakistan. Abbas et al., (2011) examined Impact of Foreign Direct Investment on Gross Domestic product. They use GDP is as dependent variable whereas FDI and inflation are taken as independent variables. They collect the data from SAARC countries over the period of They conclude their study as there is a positive and significant relationship between GDP and FDI while there is insignificant relationship between GDP and inflation. Omankhanlen (2011) examined the effect of exchange rate and inflation on foreign direct investment and its relationship with economic growth. He applies linear regression analysis for finding the relationship between inflation, exchange rate, FDI inflows and economic growth. For his purpose, he collects the data for thirty years. He found that Inflation has no effect on FDI. On the other hand exchange rate has effect on FDI.Gaurav Agrawal, Mohd. Aamir Khan (2011) examined the impact of FDI on GDP Growth. They collect the data from 5 top Asian countries respect of GDP during the period of By using the regression model they conclude that FDI promotes economic growth and an estimate that if one dollar of FDI is added it will cause 7 dollars GDP increases of each of the five countries. COPY RIGHT 2013 Institute of Interdisciplinary Business Research 238

4 The remainder of this paper is organized as follows. Section 2 discusses the data and methodology. Emperical results and their discussion are presented in section 3. Conclusion and recommendation are the subject of the final section. 2. Data and methodology: 2.1 Data collection: As the basic purpose behind this paper is to examine the impact of change in GDP and change in INF on foreign direct investment in Pakistan. Secondary data has been collected from the duration of Data is collected from ADB and SBP websites. 2.2 Theoretical framework: Gross Domestic Product Foreign Direct Investment Inflation Niazi (2011) used the same model to investigate the impact of FDI on Economic Growth and inflation in Pakistan. 2.3 variables: In this paper change in FDI is taken as dependent variables while change in GDP and change in INF are taken as independent variables to come to know that how independent variables that is inflation and GDP are effected by foreign direct investment. 2.4 Hypothesis: A hypothesis can be defined as a logically conjectured relationship between two or more variables expressed in the form of a testable statement or in simple words we can say that hypothesis is the statement of purpose. The null hypothesis is a statement that shows exact relationship between two variables, and this statement is expressed as no (significant) relationship between two variables or no (significant) difference between two groups. The alternative hypothesis is a statement expressing a relationship between two variables or indicating differences between groups. There are two null and two alternative hypothesis in this research study and these are; H 01 = there is no relationship exist between FDI and GDP in Pakistan. H a1 = there is positive or negative relationship exist between FDI and GDP in Pakistan. H 02 = there is no relationship exist between INF and GDP in Pakistan. H a2 = there is positive or negative relationship exist between INF and GDP in Pakistan. 2.5 Model A multiple regression model is used to check the significant impact of FDI on economic growth. The model is as follows; ΔFDI = α+ β 1 GDP + β 2 INF+ COPY RIGHT 2013 Institute of Interdisciplinary Business Research 239

5 INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS Where, VOL 4, NO 9 ΔFDI = Change in Foreign Direct Investment GDP= Gross Domestic Product INF= Inflation Rate FDI is the dependent variable. In the above model whereas GDP and INF are independent variables. The model is same as the model used by Niazi (2011). 3. Data analysis and interpretation: 3.1 Descriptive Statistics In descriptive statistics, total numbers of observations of each variable are 21. For GDP, minimum value is 1.20, maximum value is 9.00, mean value is and standard deviation is For CPI, minimum value is 3.10, maximum value is 20.80, mean value is and standard deviation is For FDI minimum value is , maximum value is 4.22E5, mean value is E4 and standard deviation is E5.Table 3.1 shows the result of descriptive statistics. Table 3.1 Descriptive Statistics N Minimum Maximum Mean Std. Deviation Gross Domestic Product Consumer Price Index Foreign Direct Investment Valid N Correlation Correlation analysis identifies the direction of relationship between dependent and independent variables. GDP and CPI is -17.3% correlated. There is -2% correlations between FDI and CPI. 38.9% correlation exists between FDI and CPI and all the variables have 100 % correlation among themselves. Table 3.2 shows the result of correlation. Table 3.2 Correlation 3.3 Regression Statistics GDP CPI FDI GDP 1 CPI FDI Regression statistics of proposed mode is presented in table 3.3. The results suggest the overall modelis significant at 5% level of significance because its p value is The value of R is which indicates the percentage variation in FDI due to CPI. Coefficient of determination is very commonly used of fit for regression models and is denoted by R square, which shows the proportion variance in the dependent variable that was explained by the variation in dependent variable. The R square result shows that 31% variation in FDI is explained by GDP and CPI and rest of 69% % variation in this model is unexplained. F statistics is the statistical ratio of regression mean square (MSR) and COPY RIGHT 2013 Institute of Interdisciplinary Business Research 240

6 error mean square (MSE); it is used to determine the significance of overall regression model in regression analysis. The value of f statistics in above model is Table 3.3 Regression Statistics R 0.45 R Square 0.31 Standard Error F-Statistics P-Value No. of Obs Regression equation: Simple linear regression is based on the slope _intercept equation of a line; The regression equation of this analysis is; FDI= GDP INF ΔFDI = α+ β 1 GDP + β 2 INF+ This result shows that for each unit increase in GDP, FDI is predicted to increase by units and for each unit increase in INF; FDI is predicted to increase by units. α= which shows the average value of the dependent variable FDI when there is no change in GDP and INF. This shows there is positive associate increase in FDI of because of increase in GDP. The finding of this paper are compatible with the work ofniazi et al(2011), Nair-Reichert and Weinhold (2001) and Li and Liu (2004). 4. Conclusion and Recommendations: FDI is dependent on GDP rate and INF rate in the economy of Pakistan. By using the regression analysis we conclude that FDI has direct relation with INF also positive relation with GDP, which means that with every increase in GDP rate FDI will increase and with every increase in INF rate FDI will increases. This conclusion is based on the data of 21 years ( ), so this shows that during this period FDI is increasing by by increase in GDP rate and FDI is increasing by by increase in INF rate.we were expected a positive relationship between FDI and GDP in the economy. Following are the recommendations from this research study; 1. By introducing the facilities for FDI it will help to encourage foreign investors to come and invest in Pakistan. 2. FDI can lead to indirect productivity gains through spillovers. 3. FDI may provide better access to technologies for the local economy, so we must offer free trade for encouraging the FDI. 4. The increase flow of FDI in a country has given a major boost to the country's economy which will help to increase GDP rate. 5. Hence measures must be taken in order to ensure that the flow of FDI in a country must continue to grow. 6. Reduce indirect taxes. 7. Balance social equity. 8. Focus on cottage industry. COPY RIGHT 2013 Institute of Interdisciplinary Business Research 241

7 9. We can attract FDI by increasing ease of doing business in a country which will lead to increase in GDP and CPI. 10. We can also attract FDI by targeting specific sectors of the economy which helps in development of such sector in the economy. 11. FDI would be increase by focusing on export oriented FDI. 12. FDI can also attract technology and localize production by encouraging local producer to work better by the use of such technology which leads growth in GDP. COPY RIGHT 2013 Institute of Interdisciplinary Business Research 242

8 INTERDISCIPLINARY JOURNAL OF CONTEMPORARY RESEARCH IN BUSINESS References: VOL 4, NO 9 Alex Ehimare OMANKHANLEN (2011) The Effect of Exchange Rate and Inflation on Foreign Direct Investment and Its Relationship with Economic Growth in Nigeria ISSN Alfaro, Chandra, Kalemli-Ozcan, and Sayek (2000) FDI and Economic Growth, The Role of Local Financial Markets. Harvard Business School. Working Paper Anokye M.Adam & George Tweneboah (2009) Foreign Direct Investment and Stock Market Development: Ghana s Evidence International Research Journal of Finance and Economics Issue 26. Baharumshah, A., & Thanoon, M. (2006). Foreign capital flows and economic growth in East Asian countries. China Economic Review, 17, Chadee, D.D., and Schlichting, D.A. (1997). Foreign Direct Investment in the Asia-Pacific Region: Overview of Recent Trends and Patterns, Asia Pacific Journal of Marketing and Logistics, Vol.9, No.3, p Chakraborty, C, and Basu, P. (2002), Foreign direct investment and growth in India: A cointegration approach, Applied Economics, 34(9), Chakrabory, C. and Nunnenkamp, P. (2008); Economic Reforms, FDI, and Economic Growth in India: A Sector Level Analysis ; World Development; Vol.36, p Choe, J. I. (2003), Do foreign direct investment and gross domestic investment promote economic growth?review of Development Economics, 7(1), Chowdhury,A. Mavrotas,G.(2005), FDI and Growth: A Causal Relationship, WIDER Research Paper. Duasa, J(2007), Malaysian Foreign Direct Investment and Growth: Does Stability Matter?, The journal of Economic Cooperation, 28,2(2007): E. Borensztein, J. De Gregorio, J-W. Lee (1998) How does foreign direct investment affect economic growth? Journal of International Economics; Vol.45, No.1, p Ekpo, A.H. (1995). Foreign direct investment in Nigeria: Evidence from time series data. CBN Economic and Financial Review, 35(1): Gaurav Agrawal, Mohd. Aamir Khan (2011) Impact of FDI on GDP Growth: A Panel Data Study European Journal of Scientific Research ISSN X Vol.57 No.2, pp Hansen and Rand (2006) On the Causal Links between FDI and Growth in Developing Countries The world Economy; Vol.29, No.1, p Hsiao and Shen. (2003). Foreign Direct Investment and Economic Growth: The Importance of Institutions and Urbanization. Economic Development and Cultural Change, 51, Jyun-Yi, Wu and Hsu Chin-Chiang (2008) Does Foreign Direct Investment Promote Economic Growth? Economics Bulletin, Vol. 15, No. 12. Karimi and Yusop (2009) FDI and Economic Growth in Malaysia MPRA Paper No Li and Liu (2004) Foreign Direct Investment and Economic Growth: An Increasingly Endogenous Relationship. World Development; Vol.33, No.3, p COPY RIGHT 2013 Institute of Interdisciplinary Business Research 243

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