The Impact of Domestic Interest Rates on Foreign Direct Investment: Evidence from Pakistan

Abstract

This study examines the influence of domestic interest rates on foreign direct investment (FDI) in Pakistan. The primary objective is to assess the impact of domestic interest rates, gross domestic product (GDP) per capita, merchandise exports, and unemployment rates on FDI inflows. To achieve this, the study employs econometric techniques, including the Augmented Dickey-Fuller test and the autoregressive distributed lag (ARDL) model. Additionally, diagnostic tests are applied to secondary data spanning from 1972 to 2013, sourced from Pakistan’s Economic Survey and the World Bank. The empirical findings offer significant insights into FDI dynamics in Pakistan. The results reveal a strong positive relationship between domestic interest rates, GDP per capita, and unemployment rates with FDI inflows. These findings suggest that higher domestic interest rates, economic prosperity, and lower unemployment levels serve as catalysts for attracting foreign investment. However, the study also highlights the need for a balanced approach in managing interest rates to maximize FDI benefits while safeguarding domestic investment interests. Policymakers must regulate interest rates at an optimal level that encourages foreign investment without negatively impacting local businesses. Striking this balance is essential for fostering an investment-friendly environment that promotes sustainable economic growth. The study provides valuable policy recommendations to enhance FDI inflows and strengthen Pakistan’s economic framework. By maintaining macroeconomic stability and implementing strategic investment policies, Pakistan can leverage FDI as a key driver of economic expansion and long-term development.