Economic Misery, Exchange Rate, Interest Rate, and Foreign Direct Investment: Empirical Evidence from Pakistan

Abstract

This study examines the relationship between economic misery, exchange rate, interest rate, and foreign direct investment (FDI) in Pakistan from 1972 to 2013. Using time series data sourced from various editions of Pakistan’s Economic Surveys, the State Bank of Pakistan, and the World Development Indicators, the study applies the Augmented Dickey-Fuller and Phillips-Perron unit root tests to assess variable stationarity. The Autoregressive Distributed Lag approach is employed to examine cointegration among the variables. The empirical findings reveal that economic misery and political instability have a negative but statistically insignificant impact on FDI in Pakistan. In contrast, the exchange rate exhibits a positive and significant relationship with FDI over the analyzed period. Despite the vital role of exports in the economy, the study identifies a negative and insignificant impact of exports on FDI. Interest rate and GDP emerge as key determinants, both demonstrating a positive and significant relationship with FDI, suggesting that lower interest rates and higher GDP levels contribute to increased foreign investment inflows. These findings highlight the importance of macroeconomic stability and favorable investment conditions in attracting FDI. While exchange rate, interest rate, and GDP positively influence FDI, addressing economic challenges such as political instability and weak export performance remains crucial. The study provides valuable insights for policymakers, emphasizing the need to enhance economic stability, improve investment-friendly policies, and mitigate risks associated with instability to bolster Pakistan’s attractiveness as a destination for foreign direct investment.