Exchange rate volatility and foreign direct investment (FDI) behavior in Pakistan: A time series analysis with auto regressive distributed lag (ARDL) application

Abstract

This empirical study is an effort to find the impact of exchange rate volatility on foreign direct investment for the Pakistan economy. A secondary time series data set is utilized over the period 1980 to 2010. The most robust and modern technique of auto regressive distributed lag (ARDL) has been applied to find the short run as well as the long run estimates of the study. Furthermore, after establishing the long run relationship multivariate vector error correction method (VECM) causality test has been applied to find the direction of causality between the aforementioned said variables. This analysis included real gross domestic product (GDP), capital account balance, trade openness, real exchange rate and volatility of exchange rate as independent variables along with the introduction of a dummy variable for the structural adjustment programme implemented during the late 1980s as explanatory variable, while foreign direct investment as dependent variable. Major findings of this study included that exchange rate volatility has negative impact on FDI inflow in short run while this impact is positive in the long run. It has found that adjustment and liberalization programme has favourable outcomes in the short run for Pakistan. Key words: Volatility of exchange rate, foreign direct investment, auto regressive distributed lag (ARDL) methodology.

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