Impacts of Inflation, Interest, and Exchange Rates on Foreign Direct Investment in Bangladesh: An Econometric Analysis

Abstract

Foreign direct investment is crucial for the economic development of any country, especially the developing ones. If a country's economy is to be established on a strong foundation, there is no alternative to encouraging investment situation. For this reason, economists and policy makers of almost every developing and emerging country are regularly researching the factors that influence FDI and suggesting various steps to attract more FDI in their countries. Bangladesh is far behind in this regard. This study is conducted on annual time series data over a period of 39 years from 1980 to 2018 of Bangladesh to examine whether the host country's inflation rate, interest rate, exchange rate and some other macroeconomic variables such as external debt, current account balance, gross national expenditure and air transport (proxy of transport facilities) as well as their volatilities have any impacts on the country's FDI inflows. The study investigates the long-run, short-run, and causal relationship between dependent and independent variables. Firstly we identify the key determinants of FDI by reviewing a handsome amount of literature. Among the variables frequently used in the literature, market size has been found to be the most important determinant of FDI. Almost all researchers have reached a consensus on its positive role on FDI. Economic growth, trade openness, regional trade agreement, infrastructure facilities, past FDI stock, and human capital have also been found to be the most important determinants of FDI, the positive role of which is not much disputed among the researchers. Inflation rate, interest rate, exchange rate, labor cost, corporate tax rate, and external debt have been found as the critical determinants of FDI. Although these variables are found to be significant in different countries, their role is highly controversial. Secondly, analyze the effects and causalities of our predictor variables on FDI. For estimation purpose we employ various econometric techniques. ADF and PP unit root test show that all the variables are stationary at their first differences. Johansen cointegration test indicate that there exists a long-run relationship between dependent and independent variables. The results of VECM indicate that this long-run relationship is not significant. The results of Wald test reveal that interest rate and gross national expenditure have a significant negative impact on FDI in the short-run. The other variables are found insignificant.