The Determinants Of FDI Inflow And Its Impacts On The Economic Growth Of Bangladesh:an Empirical Stutdy

The 1990s marked the most revolutionary era in the arenas of trade and economy especially of least developed countries(LDCs).The policy of the openness of economy adopted by these countries triggered a huge speed in international trade multiplying the total volume of export and import.The change and feasibility,drawn in the economic policies of these countries,lowered-down the barriers of inter-country trades and investments.With these liberal initiatives in trade,the scope of Foreign Direct Investment(FDI)also gets pace contributing to both host and home countries.Previously,the foreign currency loans and foreign aids were the main sources of external capital for the developing country like Bangladesh.However,since the 90s of the last century,FDI inflows started to occupy a significant position in the list of foreign capitals.With a large number of population with lower per capita GDP,Bangladesh is presumed to be immensely benefitted by FDI.Providing local investment is not the sole means by which FDI can contribute to the economy of the country.It also generates employment,introduces modern technologies,and increases local competition which results in the enhancement of the economy.Considering the necessity of FDI in the economy of the country,the Government of Bangladesh has taken different measures to open up its economy towards foreign investors.The most remarkable initiatives are trade liberalization,foreign investment policy modernization,and favorable industrial policy formulation.All these policy adaptations turn Bangladesh into an open FDI locale especially in South Asia.In fact,the comparative advantage of cheap labor,strategically favorable geographical location,stable growth rate,market size,macroeconomic environment,and the possibility of a significant amount of natural gas mark a profitable environment for the investors to invest in Bangladesh.However,the FDI inflow in the country is not satisfactory.This is mainly caused by poor physical infrastructure,unstable political environment,low quality of human capital,insecure formal institutions(legal system,property rights,and finance system),high levels of public bureaucracy,low level of technology,lack of innovation,lack of R&D,low degree of integration(fewer networks and links),high degree of state intervention,rigid formal and informal institutions,weak informal institutions(culture,social relations,ethics,religion),poor implementation of the new,slow government decision-making,corruption,labor militancy,a sometimes-uncertain law and order situation,inadequate commercial laws and courts,and policy instability.Though the FDI inflow in Bangladesh reaches to $2235 million US in 2015-2016 from $3 million US in 1990,the increase is not significant comparing to other South Asian countries.Though there are many studies on FDI inflows of different countries over the world,studies are significantly few on that of Bangladesh.Moreover,it appears that most of the studies on Bangladesh employ GDP per capita as the proxy to market size of the country.But the problem of using GDP per capita to measure the market size is that it cannot always represent the actual demand of the country.Because population size of a particular country determines the per capita GDP of that country.In this context,a country like Bangladesh with people of lower per capita income may not demonstrate its potential market size since it has a huge number of population(160 million).Pointing to it,this study finds it significant to use GDP instead of GDP per capita as a proxy to the market size of the economy of Bangladesh.Furthermore,though the previous studies cover many determinants of FDI,they overlook some important ones comprising infrastructure development,political risk,and exchange rate.Without taking the influence of these determinants into consideration,studies on FDI inflows of Bangladesh cannot be acute.Drawing on these drawbacks of the existing studies,this paper sets for a fuller and scientific study of the determinants of FDI inflows in Bangladesh.It has empirically analyzed the co-relation of determinants and FDI inflow of the country using ARDL framework.It uses annual time series data and the study period span over 1972-2015.The data are taken from World Development Indicators of World Bank,UNDP,Economic Trends of Bangladesh Bank,and Bangladesh Economic Reviews.This dissertation is organized in seven chapters.The first and the last chapters stand for its introduction and conclusion respectively.Current economic situation of Bangladesh,theories of FDI,and trend of FDI inflows are described respectively in second,third,and fourth chapters of the study.The fifth and the sixth chapters are empirical which together formulate the main focus of the study.The fifth chapter provides a study on the determinants of FDI in Bangladesh while the sixth one shows the impacts of FDI on her economic growth.To attain sufficient FDI,the first think to determine is to identify the controlling factors of it.The present study employes ARDL model or bound testing cointegration procedure to examine long-run and short-run relation of the variables and their dynamics interactions.The independent variables of this study are the market size(GDP),inflation,openness,political risk,infrastructure development,and exchange rate while the dependent variable is FDI inflows.Before applying the ARDL model,all the variables are tested for their time series properties(stationarity properties).According to Pesaran et al.(2001),the precondition of applying ARDL model is that the order of intigration of the variables must not exceed I(1).In order to check this applicability of the model,this paper operates three unit root tests namely Dickey-Fuller GLS,Augmented Dickey-Fuller(ADF),and Phillips-Perron(PP).The results of these tests find that some variables are stationary at level and the others are at first difference.They confirm that not a single variable is at second difference order,I(2).Therefore,the study proceeds to apply ARDL approach to investigate the cointegration of the variables.The study employs AIC,SIC,and HQ to determine the optimum lag length for the cointegration bound test.Lag 4 is taken as the optimum lag length which generally influences the results of the test.According to the results of ARDL,the bound test(F-statistic)value is larger than the upper bound critical value both for Pesaran et al.(2001)and Narayan(2005)which indicates there is a long run relationship between FDI and its determinants of GDP,inflation,openness,political risk,infrastructure and exchange rate during the study period in Bangladesh.This implies that the study rejects the null hypothesis of no cointegration and accepts the alternative hypothesis to conclude there exists a long-run cointegration among the variables.As the long-run estimated result of the study shows that the GDP,which is used as a proxy for the market size of Bangladesh,has positive influence on FDI inflows and it is highly statistically significant at 1%significance level.The positive coefficient indicates that higher GDP is associated with higher growth rates of FDI inflows.One unit increase in infrastructures leads to approximately 1.209778 unit increase in FDI inflows.It means the sign of the coefficient of infrastructure is consistent with prior expectation,and it is highly statistically significant.In the long-run,the exchange rate is negative(-0.013295)which is also relevant to the study hypothesis and statistically highly significant.The long-run equation shows a high explanatory power and the F-statistics are statistically significant which means that all independent variables jointly explain the dependent variable(FDI)in Bangladesh.Though inflation,openness,and political risk appear statistically insignificant in the study,their coefficient signs are consistent with the hypotheses.If the government takes measures in policy formulation declining constraints of business climate,these determinants will also cast positive impact in inviting FDI inflows.There exist some other determinants(i.e.,low cost of labor,favorable geographical location,sustained growth rate,stable macroeconomic environment,and potential market size)influencing the FDI inflows positively which are analytically discussed in the study due to different reasons.The coefficient of the error correction term(ECT)indicates how quickly the variables converge to equilibrium meaning that how cointegrated the relationship between the variables are.The ECT(-1)result demonstrates a high speed of long-run equilibrium adjustment of 86.62%every year after a short-run shock.The coefficient of determination(R-squared)is high explaining that about 81%of variation in the determinants of FDI is attributed to variations in the explanatory variables in the model.Therefore,the ECT test suggests that the determinants and FDI inflows are cointegrated in the long-run.Diagnostic tests are performed on the residuals.If the residuals are serially correlated and have non-constant error variance,it may indicate that the model is not efficient and as such the parameters estimated could be biased.The results of the diagnostic tests indicate that the model has no serial correlation,no heteroscedasticity problem,and normally distributed.Finally,it is seen that the model is stable as it confirms the conditions of CUSUM and CUSUMSQ tests.The study also investigates into the relationship between the indicators of governance quality and FDI inflows.Using qualitative method,it has found a positive impact of governance quality on the FDI inflows.The figures show that the countries,which have good governance qualities such as less corruption,better government efficiency,stable political environment,sound regulatory quality,a stronger rule of law,and voice and accountability,are associated with larger FDI inflows.It could be concluded that if the governance performance in Bangladesh becomes good,it will provide good investment climate and attract more FDI in the long run.The impact of FDI on the economic growth of Bangladesh over the study period is examined by VECM model.The growth of GDP is chosen as the dependent variable and it is controlled by four explanatory variables.The explanatory variables are most important components of GDP growth according to the previous empirical literature on economic growth theory in the global perspective.The openness,capital,and labor force are chosen in addition to the FDI net inflows.The cointegration result implies that there is a long-run relationship between the variables under the study meaning that when the net inflows of FDI increases in Bangladesh,GDP growth follows in the same direction.In other words,FDI causes GDP growth in Bangladesh which is supported by Toda-Yamamoto(1995)Granger causality test.The coefficient of FDI is revealed to be positive and statistically highly significant in the empirical study which supports the conclusions about the positive impact of FDI upon GDP growth.In addition,the negative coefficient of ECT confirms the long-run equilibrium relationship between the variables.According to Toda-Yamamoto(1995)Granger causality test done by using annual data from 1972 to 2015 in Bangladesh,foreign direct investment,Ln(FDI)does Granger cause the growth of GDP,Ln(Y).To formulate differently,there exists a causal relation running from Ln(FDI)to Ln(Y)because its P-value is almost zero.So,we can easily say that FDI influences the economic growth in Bangladesh.Again,the growth of GDP does Granger cause the FDI inflows because its P-value is also less than 1%which is statistically highly significant,so we can reject the null hypothesis and accept the alternative.It means economic growth is an influential factor in FDI inflows.Therefore,it can be concluded that FDI Granger causes GDP growth.It means that the current GDP growth rate is immensely facilitated by the past values FDI.So,it can be considered there exists a bi-directional causality from FDI to economic growth in Bangladesh because its P-value is less than 1%which is highly statistically significant.This result is also consistent with chapter five that says determinant of market size or GDP influences the FDI inflows in Bangladesh.So,this Toda-Yamamoto Granger causality does support the previous statement.To conclude,the study first finds out the determinants that influence the FDI inflows of Bangladesh.Then,it discovers that the increase of FDI inflow immensely contributes to the economic growth of the country.It finds that some factors are positively controlling the FDI inflows while some other factors need to be revived by adopting new policies.In order to encourage more inward FDI in the country,the policy makers have to concentrate on improving each component of investment climates such as time of starting and doing a business,time of getting electricity,time of registering property,and cost of export and import.Moreover,the country needs to invest a lot on the different sectors of infrastructure,i.e.,energy,power generation,roads and highways,railway and sea ports to attract further foreign investors.