The Impact of Political Instability and Nominal Interest Rate on Foreign Direct Investment. The Case of Pakistan

Essay, 2021

19 Pages, Grade: 14




1.1 Background of the study
1.2 Objectives
1.3 Limitation of the study
1.4 Layout of the study

2 Literature Review
2.1 Literature from Developved World
2.1.1 Literature From Developed World
2.1.2 Literature from developing World
2.2 Theoretical review
2.3 Summary: Rationale of the Study

3- Conceptual Framework and Strategy
3.1 Model Specification
3.2 Variable Description
3.3 Data sources

4 Research Design and methodology
4.1 Model specification
4.2 Methodology
4.3 Results and discussion

5 Conclusion
5.1 Policy suggestion


7 Appendix


This paper will focus on the impact of domestic interest rate and political instability on FDI of Pakistan using time series data from 1989-2019 in case of Pakistan and we have used multiple regression techniques, and other OLS techniques to find out the desired results and we also find the relation for the short time period and for long time period using autoregressive distributed lag model(ARDL)as well. We have also used Augmented Ducky fuller test to check the stationarity of the data. our findings are political instability have major impact for short time period and in long time period but in case of interest rate there is a negative minimal impact on FDI in both span of time. This can be because when you have lower nominal interest rate then your domestic investor will get benefit and country GDP will rise then FDI will automatically rise and Pakistan has many domestic problems of attracting FDI like terrorism, political instability etc. . Our research’s I will be open ended and there will be a always a need of better modification.

KEYWORDS: Domestic nominal interest rate, FDI, Political instability, Multiple regression, ARDL techniques, ADF test


1.1 Background of the study

Foreign Direct Investment is a core ingredient in the economic development of any country and it is also a result of globalization. According to world Bank world inflow of FDI has almost more than tripled ,in 2001 it was 6.51 US $ to 23 Billion $ In 2020 and major share of this inflow was developing countries such as china India contribute almost 25% and remaining share goes to developed countries FDI is done on many developing countries because of availability of cheap labor, uninterrupted availability of raw materials, less production cost compared to developed countries and quick and easy penetration into the markets and many others factors which can bring energy to the stagnate economies through inflow of FDI. . It is a booster for a staggering economy according to many economist and policy makers and today many of the modern developed countries like china have witnessed of this booster(FDI) and before dipping into the ocean we must understand the FDI in every angles.

Direct Investment is an investment made by a firms, individuals into a business which is located into another country and that foreign investor have controlled in that business and according to Organization Of Economic Corporation and Development(OECD) the foreign investor must have at least 10% or more share into that business in which he is investing .FDI (real investment) is also refers as a purchasing of physical assets like machinery ,building etc. into another country ,it may also include transferring of technology into the host country like Apple which is a US company but their major share of production in china .Businesses that invested into other countries are called multinational corporations . we must also know about financial investment (portfolio investment) in which purchasing of shares by a foreign investor of an existing companies and buying of bonds, this type of investments is short term. This type of investment provides “hot money “to the host country and improve the foreign exchange reserve.

According to IMF (2011) “FDI is an investment that is made to get lasting interest in a company operating in an economy other than the investor.” and collaboration of IMF and OECD defines the FDI as international venture in which investor residing in home country acquire the long term influence on the management of the firm in the host economy (OECD,2008). In these above definition there has been explained long term and lasting effect of a foreign company on the host economy firm which is a indicator of distinguished between FDI and foreign portfolio investment because this type of investment is short term . There are also some types of FDI as well for examples horizontal FDI in which parent industry of a foreign country invested in the same firm with respect to production in the host country .for example if Toyota (japan) invested on the Mercedes (Germany) this investment will be horizontal because both these manufacture almost same products. Vertical FDI within the supply chain, not directly into the same industry and third one is conglomerate in which investment is made into completely different industry by a parent company for example Nestle made the investment in Honda industry .and the last one is platform FDI in which business expands into the foreign country but the product manufactured are exported to the third country ,e.g. French perfume brands set up manufacturing in USA and exported to other countries . if we discuss the trends of FDI with respect to Pakistan from 1989 to 2019 then we see the ups and down with the time and we didn’t see the continuous climbing due to short term policies and lack of govt. interest rate in attracting FDI and if we see the recent era of 2015-16 there has been sharp rise of 38.8% in the FDI because of china net outflow of .6 Billion dollars to the Pakistan (SBP) and more than half of investment of FDI is alone from china due to CPEC (china –Pak economic corridor) which is also 64$ project. and

According to UNCTAD (united nation conference on Trade and Development) 2020 world investment report inflow of investment has increased from 1.7 billion USD $ (2018) TO 2.2 billion USD $ in 2019 and total stock of FDI was 34.8 Billion at the end of 2019 and in the first half of 2019-20 FDI rose by 68.3% (SBP) and 30 months’ record high investment was in Dec. of 2019 which was 487 million USD, which was mainly in the chemical and construction industry. the major contribution of FDI in Pakistan is CHINA, UK, USA, JAPAN AND SOUTH KOREA and Avg. FDI inflow is 163.65 million USD from 1990-2019 .With FDI ,investors can access to new market ,new resources and can reduce cost of production via cheap labors and there also a bundles of advantages to the host countries in terms of infrastructures development ,technology transformation ,employment opportunities and many more . foreign direct investment (FDI) is found to raise the productivity level and build a competition among producers which results in a production of quality products (Yousaf et al., 2008) and FDI brings advanced production techniques, snobbish managerial skill ,advertising and marketing expertise .According to Romer(2001)FDI is a very core element of a sustain economic growth and increase long run productive capacity of an economy .and Pakistan govt. has trying to climbs up the volume of FDI in many sectors such as in mining sectors ,tourism sectors etc. But there are some also drawbacks of FDI as well because its increase the complexity of local markets ,exploitation of cheap labor ,low technology transfer and transfer of benefits to their home country, exploitation of natural resources and sometimes have negative influence on your exchange rate .

Pakistan has many problems to attract a handsome amount of FDI which Pakistan has actual potential, these hindrances may be in the form of security situation, electricity shortage and burdensome investment climate. but every govt. is trying is best to enhance FDI inflow by making supportive laws Protection of Economic Reforms act 1992 and Foreign Private Investment Act 1976 .due to these effective efforts Pakistan has improved 28 points in Ease of Doing Business of 2020 and stand at 108th position out of 190 countries and Pakistan is attracting less FDI than its neighbors country like India ,policymakers should adjust the interest rate in a that it gives appetizing to the foreign investors and also does not hurt to the domestic industries as well. Pakistan has FDI which is only 1% to the country GDP which is not enough with the 220 million market. And if we make SWOT analysis of business environment to attract Foreign Direct Investment we can say this

Abbildung in dieser Leseprobe nicht enthalten

Editorial Note: This diagram was removed due to copyright issues

In the above pie-diagram the major portion is security problem and due to this our FDI s low and we are unstable get catch –up effect But the major hindrance in way of Pakistan FDI and economic growth is political instability and unfortunately Pakistan has lacking this blessing from independence time and since this is a common phenomenon which create hindrance in economic growth and shaking the confidence of foreign investors as well (Akhter,2000) and if we see the Pakistan history it seems like zigzag path of democracy and marshal laws means we didn’t have any stable govt. due to this our political parties intervene economic decisions ,legal property decision and through many other ways to create a dilemma for a foreign investor to rethink billion time before investing a single penny and we are observing the negative relation political instability with FDI inflow and according to political stability if we talk about the interest rate, Pakistan nominal interest rate is standing at 7% currently which is lower than avg. (11.15%) because of to brace the local industry due to this covid. 19 pandemic if we see the trends from 1990s then we that interest rate all time in oct.1996 which was 19.50% and record low in 2016 which was 5.5% in terms of nominal and Pakistan have 3.3256% real interest rate (inflation adjusted )currently and Pakistan have experienced high FDI inflow when our domestic interest rate was high we have high interest rate means FDI will be also be high because when our domestic interest rate is high its gives incentive to foreign investors to invest in that country to get high returns .

To measure political stability we used the value +2.5 for strong and -2.5 for weak means more political instability. if we see the trend of Pakistan ,we mostly have the political instability in our inheritance since from independence and with avg. of -2.12 from 1989 to 2019 .and this malady is severe in Pakistan because it is a prerequisite for economic development ,social integration and for supremacy of law .

In short we can say that instability of Govt., inefficiencies of political parties and weak political culture can create the scenario of political instability in the country. according to Lucian (1971) political instability is due to identity crisis, legitimacy crisis, penetration crisis, participations crisis and distribution crisis .and if we see Pakistan it’s also revolving around these dome . Husain (2009) studied that beneficiary business environment heavily relay on the political situation of the country, more political stable country, you have more chances to attract FDI .unfortunately in our country when there is spending on development project ,all parties engaged to criticize to the ruling party but if same expenses spends on non-development projects (their salaries ,their houses etc.) they become deaf animals and this kind of political structure always create the Foreign Direct Investment is one of the engines that ignites the economic growth in the developing countries in the current era (Alie Faroah,2012) ,FDI effects the economy through many channels like labor training, market development ,financial inflow ,minimize the shortage of financial resources ,technological development for the host countries .but in Pakistan FDI is continuously low which leads lower economic growth and lower standard of living instead of having( 220 million) gigantic market size ,cheap labor, natural resources abundance ,huge capacity of tourism industry . if we see our study even Pakistan has comparatively higher interest rate (7%) than south Asian economies e.g. India (5.56%) but our FDI has comparatively less than other south Asian economies like India, this we try to figure out the reason and recommended solutions of these MALADIES.

ones in way of FDI .

1.2 Objectives


1)determinants of Foreign Direct Investment in Case of Pakistan

Specific objectives

1)To determine the effect of domestic nominal interest rate on FDI (in case of Pakistan using time series data from 1989 -2019)
2) the impact of political stability on FDI (in case of Pakistan using time series data from 1989 -2019)
3) find the possible ways to boost the Foreign Directs Investment (in case of Pakistan)

Research Questions:

1)what is the relation of domestic nominal interest rate on FDI in Pakistan
2)what is the impact of political instability on FDI (Foreign Direct Investment) in Pakistan

Research Hypothesis

1) Political instability and nominal interest rate WILL have positive effect on FDI(H0)(NULL HYPOTHESIS)
2 )There will be negative effect of nominal interest rate and political impact on FDI(H1)(ALTERNATIVE HYPPTHESIS)

1.3 Limitation of the study

In Our research paper we have taken only 2 determinants of FDI which are political instability and nominal domestic interest rate in case of Pakistan ,and there are many other determinant as well which can effect FDI ,these are GDP ,exchange rate ,balance of payment etc. and we consider these variable as a controlled variable and our result will catch only the variation which comes from these two exogenous variables.


Excerpt out of 19 pages


The Impact of Political Instability and Nominal Interest Rate on Foreign Direct Investment. The Case of Pakistan
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This paper will provide you deep insight to understand the Pakistan Economy.
impact, political, instability, nominal, interest, rate, foreign, direct, investment, case, pakistan
Quote paper
Asif Hussain (Author), 2021, The Impact of Political Instability and Nominal Interest Rate on Foreign Direct Investment. The Case of Pakistan, Munich, GRIN Verlag,


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