National University of Modern Languages

Submitted to:
Prof. Waseem Abbas

Submitted by:
Hasseeb-ur-Rehman Omer Ejaz

Summary

This paper investigates the impact on foreign direct investment due to the Inflation (Consumer Prices), Official Exchange Rate, GDP

(Current $ USD), GDP Growth Annual Percent Rate & Total Tax Rate of Commercial of (03) three Asian countries i.e Pakistan, Bangladesh & India. Secondary data has been gathered from the websites and articles during the time period of 1980 to 2011 for this purpose. In this paper, five variables are used INF, GDP (Current & Growth), ER, TR are taken as dependent variable whereas FDI is taken as independent variables. To assess the impact of FDI on five dependant variables, time series data regression has been used.

Introduction

The issue of economic growth asymmetry across countries continually draws academic interest and intellectual curiosity. What really contributes to this asymmetry has puzzled the minds of economists and politicians for centuries. The new millennium raises more questions and concerns about this issue. As a result, there is a growing need to study it with more rigor and depth. Many less developed countries (LDCs) have adopted outward- and forward-looking policies to promote economic growth and employment. The roles of exports, foreign direct investment (FDI) and the concomitants remittances of emigration are recognized as important economic Growth-enhancing factors.

Although the adoption of such policies by LDCs is expected to exert positive influences on overall GDP, it is uncertain how much is contributed by surging exports, FDI, and remittances. The empirics of their effects on GDP generate mixed and ambiguous inferences across countries over different sample periods and across different developing countries. Therefore, this paper re-examines the roles of these causal variables in promoting real GDP of Pakistan, Bangladesh, & Pakistan.

These three developing countries of South Asia have been selected because of emphasizing active policies of export promotion and diversification, increasing manpower exports and enticing FDI to boost economic growth as important members of SARC (South Asian Regional Cooperation). The remainder of the paper is organized as follows: section II reviews some of the related literature. Section-III outlines the empirical methodology. Section IV reports the empirical results. Finally, Section-V offers conclusions and policy implications.

Foreign Direct Investment and GDP Growth

There is conflicting evidence in the literature regarding the question as to how, and to what extent, FDI affects economic growth. FDI may affect economic growth directly because it contributes to capital accumulation, and the transfer of new technologies to the recipient country. In addition, FDI enhances economic growth indirectly where the direct transfer of technology augments the stock of knowledge in the recipient country through labor training and skill acquisition, new management practices and organizational arrangements Foreign Direct Investment (FDI) is very important to developing countries. Though foreign direct investment, individuals or corporation obtain partial or total ownership of firms located in another country. But foreign investor should have lasting interest and substantial control over the investment. FDI contribute to growth through several channels. It directly affects growth through being a source of capital formation. As a part of private investment, an increase in FDI will, by itself, contribute to an increase in total investment. An increase in investment directly contributes to growth. A large number of studies have been done in the field of foreign direct investment and economic growth. FDI is an important category of international investment that shows a long-term relationship between the direct investor and the enterprise. It indicates the influence of the investor on the management of the enterprise. Direct investment relates the initial transaction between the investor and the enterprise. It also shows the transactions between them and among affiliated enterprises, both incorporated and unincorporated.

Foreign Direct Investment and Exchange Rate

The investigation of relationship between exchange rate as well as its volatility and macroeconomic variables including foreign direct investment got significant importance in last few decades, particularly after the collapse of Bretton woods in 1971. After the collapse of this system, majority of the countries initiated the flexible/floating exchange rate system and faced huge fluctuation in the value of their currency prices.

The growing interest in foreign direct investment (FDI), stand from the perceived opportunities derivable from utilizing this form of foreign capital injection into the economy to augment domestic savings and further promote economic development in most developing economies.

FDI is believed to be stable and easier to service than bank credit. FDI are usually on long term economic activities in which repatriation of profit only occur when the project earn profit. As stated by Dunning and Rugman (1985). Foreign Direct Investment (FDI) contributes to the host countrys gross capital formation, higher growth, industrial productivity and competitiveness and other spinoff benefits such as transfer of technology, managerial expertise, improvement in the quality of human resources and increased investment.

Other factors like higher profit from investment, low labour and production cost, political stability, enduring investment climate, functional infrastructure facilities and favourable regular environment also help to attract and retain FDI in the host country.

Foreign Direct Investment and Inflation

Modern growth theory rest on the view that economic growth is the result of capital accumulation which leads to investment. Given the overriding importance of an enabling environment for investment to thrive, it is important to examine necessary conditions that facilitate FDI inflow. These are classified into economic, political, social and legal factors. The economic factors include infrastructural facilities, favorable fiscal, monetary, trade and exchange rate policies. The degree of openness of the domestic economy, tariff policy, credit provision by a countrys banking system, indigenization policy, the economys growth potentials, market size and macroeconomic stability. Other factors like higher profit from investment, low labour and production cost, political stability, enduring investment climate, functional infrastructure facilities and favourable regulatory environment also help to attract and retain FDI in the host country. Inflation as this term was always used everywhere and especially in these countries, 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 a certain outcome of inflation, that is the tendency of all prices & wage rates to rise. Foreign Direct investment can also be describe as an investment made by an investor or enterprises in another enterprises or equivalent in voting power or other means of control in another country with the aim to manage the investment and maximize profit. This investment involves not only the transfer of fund but also the transfer of physical capital, technique of production managerial and marketing expertise, product advertising and business practice with the aim to make profit. Other factors like higher profit from investment, low labour and production cost, political stability, enduring investment climate, functional infrastructure facilities and favourable regular environment.

Foreign Direct Investment and GDP Current

In measuring the impact of FDI on GDP, we expect the FDI that has come into the host country this year to contribute to an increase in the FDP from next year onwards. Note that FDI inflows in any year represent in general, the increase in FDI inward stock as defined in the World Investment Reports. Since FDI is reported in current US$, we use the GDP data also measured in current US$ to maintain consistency.

After the global financial crisis, the status and importance of Asian economies have increased a lot because of their more than expected resilience to financial crisis. Asian economies are expanding rapidly and their growing clout can be felt from the fact that out of top 5 economies of the world 3 are Asian. Asia, with the exception of Japan, South Korea, Hong Kong and Singapore, is currently undergoing rapid growth and industrialization spearheaded by China and India - the two fastest growing major economies in the world but in the present paper we have taken the economies of 3 countries i.e Pakistan, Bangladesh & India.

FDI can accelerate growth in the ways of generating employment in the countries, fulfilling saving gap and huge investment demand and sharing knowledge and management skills through backward and forward linkage in the countries.

Foreign Direct Investment and Tax Rate

Tax is classified into two main categories that is direct and indirect taxation. Direct tax is imposed on properties, incomes and corporate profits etc. Indirect tax includes value added tax, sales tax and import duty etc. In case of direct taxes, tax revenue depends on a countrys policy, either it relaxes the direct taxes for attracting foreign investment or imposes to collect revenue. For example, tax holidays and tax credits for new foreign investment and exemption of import duty in case of imports of raw material and machinery. Secondly, indirect tax depends on the sales of goods and services. FDI has generally positive effect on the economic growth and income levels in a country, so there will be greater aggregate demand and economic activities in a country which could help the government to generate more indirect taxes. In case of Pakistan, major proportion of tax revenue is collected through indirect taxes. So, FDI may have positive impact on the tax revenue in Pakistan. According to Bond and Samuelson (1986), host countries could lose some tax revenue in short run if tax holidays were given to attract FDI in early period. Tax revenue could increase in the long run because foreign investment would not pull out after that tax holiday period. Brander and Spencer (1987) stated that host countries could attract FDI by imposing tariff on imports and relaxing the tax on local production. It was stated that FDI could enhance national welfare by reducing unemployment, rising productivity through technology transfers and raising government revenue through taxation.

Empirical Results