Foreign Capital and Investment in Pakistan: A Cointegration and Causality Analysis

Sharafat, Ali and Hamid, Waqas and Muhammad, Asghar and Raheel Abbas, Kalroo and Muhammad, Ayaz and Mukhtyar, Khan (2013): Foreign Capital and Investment in Pakistan: A Cointegration and Causality Analysis. Published in: Journal of Basic and Applied Scientific Research , Vol. 4, No. 4 (29 April 2014): pp. 217-226.

Abstract

Present study is focused to examine the effects of foreign capital flows on domestic investment in Pakistan economy for the period of 1972-2013. Time series econometric techniques like unit root test, Johansen cointegration and Granger causality methods have been used for the data analysis. Long run cointegration relationship has been found between domestic investment and foreign capital flow variables. Unidirectional causality running from external debt stock, remittances and domestic saving to domestic investment has been found. The causality between external debt servicing and investment is bidirectional. Bidirectional causality is also observed between foreign direct investment and domestic investment but causality between investment and inflation is confirmed in neither direction. The results are statistically robust and the estimated model is stable. The study suggests some policy recommendations.

• Item Type: MPRA Paper
• Language: English
• Keywords: External Debt, Debt Servicing, Investment, Remittances, Domestic Saving, Cointegration, Granger Causality, Pakistan.
• Subjects: C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; F - International Economics > F2 - International Factor Movements and International Business > F21 - International Investment ; Long-Term Capital Movements; R - Urban, Rural, Regional, Real Estate, and Transportation Economics > R5 - Regional Government Analysis > R53 - Public Facility Location Analysis ; Public Investment and Capital Stock

References

Adams, Richard H. (1998). Remittances, Investment, and Rural Assets Accumulation in Pakistan. Economic Development and Cultural Change, 47: 155-173.

Afzal, M. (2007). Saving and Investment in Development Countries: Granger Causality Test. The Philippine Review of Economics, XLIV (2): 99-110.

Ahmad, A., Ahmad, N. & Ali, S. (2013). Exchange Rate and Economic Growth in Pakistan (1975-2011). Journal of Basic and Applied Scientific Research, 3(8): 740-746.

Ahmad, A., Ali, S. & Ahmad, N. (2014). Crime and Economic Growth in Developing Countires: Evidence from Pakistan. Journal of Basic and Applied Scientific Research, 4(4): 31-41.

Ali, S. (2014). Foreign Capital Flows and Economic Growth in Pakistan: An Empirical Analysis. World Applied Sciences Journal, 29(2): 193-201, DOI:10.5829/idosi.wasj.2014.29.2.1372

Ali, S. (2014a). Inflation, Income Inequality and Economic Growth in Pakistan: A Cointegration Analysis. International Journal of Economic Practices and Theories, 4(1): 33-42.

Ali, S., Mustafa, M. Q., & Shahbazi, I. A. (2013). Agriculture Value Added and Income Inequality in Pakistan: A Time Series Analysis. Research Journal of Economics, Business and ICT, 8(2): 25-33.

Ali, Sharafat & Ahmad, Najid (2013). A Time Series Analysis of Foreign Aid and income Inequality in Pakistan. Global Journal of Management and Business Research Economics and Commerce, 13(5): 10-19.

Ali, Sharafat (2013a). A Cointegration Approach to Estimate Private Domestic Investment Demand Function of Pakistan. Asian Journal of Research in Business Economics and Management, 3(9):1-13.

Ali, Sharafat (2013b). External Debt and Domestic Investment in Pakistan: A Cointegration Analysis. Journal of Managerial Sciences, 7(2): 179-191.

Ali, Sharafat (2013c). The Small and Medium Enterprises and Poverty in Pakistan: An Empirical Analysis. European Journal of Business and Economics, 8(2):25-30.

Ayyoub, M., I. S. Chaudhary and F. Farooq (2011). Does Inflation Affect Economic Growth? The Case of Pakistan. Pakistan Journal of Social Sciences, 31(1): 51-64.

Bauerfreund, O. (1989). External Debt and Economic Growth: A Computable General Equilibrium Case Study of Turkey 1985-1986. Duke University Ph. D.

Boone, P. (1996). Politics and the Effectiveness of Foreign Aid. European Economic Review, 40: 289-329.

Burki, Shahid. J. (1991). Migration from Pakistan to Middle East in D. G. Papademitriou and P. L. Martian (Ed). The Unsettled Relationship: Labor Migration and Economic Development. London: Greenwood Press.

Burnside, C. and D. Dollar (2000). Aid, Policies and Growth. American Economic Review, 90: 847-868.

Chaudhry, Imran Sharif, S. Malik, and M. Ramzan (2009). Impact of Foreign Debt on Savings and Investment in Pakistan. Journal of Quality and Technology Management, 5(2): 101-115.

Chenery, H. B., and A. M. Strout (1966). Foreign Assistance and Economic Development. American Economic Review, 56(4): 679-733.

Chishti, Salim and M. Aynul Hasan (1992). Foreign Aid, Defense Expenditure and Public Investment in Pakistan. The Pakistan Development Review, 31(4): 895-908.

Cohen, D. (1993). Low Investment and Large LDC Debt in the 1980s. The American Economic Review, 83: 437-449.

Cordela, T., Ricci, L. A. & Ruiz-Arranz, M. (2005). Debt Overhang or Debt Irrelevance: Revisiting the Debt-Growth Link. IMF Working Paper No. 223, International Monetary Fund: Washington.

Dickey, D. A. and Fuller, W. A. (1979). Distribution of the Estimators for Autoregressive Time Series with a Unit Root. Journal of the American Statistical Association, 74: 427-431.

Domar, E. (1957). Essays in the Theory of Economic Growth. Oxford University Press.

Economic Survey, Pakistan (1990-91, 1998-99, 2002-03, 2009-10, 2012-13). Ministry of Finance, Government of Pakistan: Islamabad.

Engle, R. F. K, and Granger, C. W. F. (1987). Cointegration and Error Correction: Representation, Estimation and Testing, Econometrica, 55, 251-276.

Esso, L. J. & Y. Keho (2010). The Savings-Investment Relationship: Cointegration and Causality Evidence from Uemoa Countries. International Journal of Economics and Finance, 2(1): 174-181.

Friend, I. (1981). Effects of Inflation on Saving, Investment and Capital Markets. Working Paper No.11-81, Rodney L. White Center for Financial Research, University of Pennsylvania, the Wharton School: Philadelphia, PA 19104.

Gheeraert, L., R. S. Mata, and D. Traca (2010). Remittances and Domestic Investment in Developing Countries: An Analysis of the Role of Financial Sector Development. CEB Working Paper No. 10/013. Solvay Brussels School of Economics and Management: Belgium.

Granger, C. W. F. (1988). Some Recent Developments in a Concept of Causality. Journal of Econometrica, 39: 199-211.

Gul, Adnan (2008). In External Debt an Effective Way of Bringing Economic Reforms? MPRA Paper No. 10979. Retrieved from http://mpra.ub.uni-muenchen.de/10979

Hameed, A., Hammad, A. & Chaudhary, M. A. (2008). External Debt and Its Impact on Economic Growth and Business Growth in Pakistan. International Research Journal of Finance and Economics, Issue 20.

Harrod, F. R. (1939). An Essay in Dynamic Theory. Economic Journal, March 1939, pp. 14-33.

Jafri, M. K. and H. Habib (2012). Impact of External Debt Service Papyment on the Investment of Pakistan. Proceedings of 2nd International Conference on Business Management (ISBN: 978-969-9268-06-6), March 28-29, 2012, Lahore.

Javed, Z. H. & Sahinoz, A. (2005). External Debt: Some Experience from Turkish Economy. Journal of Applied Sciences, 5(2): 363-367.

Johansen , S. and Juselius K. (1990). “Maximum Likelihood Estimation and Inference on Cointegration – with Approach to the Demand for Money”. Bulletin, Volume 52. pp. 169-210.

Johansen, S. (1988). “Statistical Analysis of Cointegration Vectors”. Journal of Economic Dynamics Control, Vol. 12, pp. 231-54.

Johansen, S. (1991). Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models. Econometrica, 59: 1551-1580.

Johansen, S. (1995). Likelihood-based Inference in Cointegrated Vector Autoregressive Models. Oxford: Oxford University Press.

Johnston, J. & Dinardo, J. (1997). Econometric Methods. McGraw Hill Companies, Inc., 4th EditionL 244-286.

Kemal, A. R. (2001). Debt Accumulation and Its Implications for Growth and Poverty. The Pakistan Development Review, 40(4): 263-281.

Krugman, P. (1988). Financing vs. Forgiving a Debt Overhang. Journal of Development Economics, 29: 253-268.

Luka, O., and N. Spatafora (2012). Capital Inflows, Financial Development, and Domestic Investment: Determinants and Inter-Relationships. IMF Working Paper No. WP/12/120. International Monetary Fund.

Lungu, M., K. Simwaka, and A. Chiumia (2012). Money Demand Function for Malawi - Implications for Monetary Policy Conduct. Banks and Bank Systems, 7(1): 50-63.

MacKinnon, J. G. (1996). Numerical Distribution Functions for Unit Root and Cointegration Tests. Journal of Applied Econometrics, 11: 601-618.

Mohey-ud-din, Ghulam (2006). Impact of Foreign Capital Inflows on Economic Growth in Pakistan (1975-2004). Journal of Independent Studies and Research, 1(5): 24-29.

Nasir, S. & M. Khalid (2004). Saving-Investment Behaviour in Pakistan: An Empirical Investigation. The Pakistan Development Review, 43(3): 665-682.

Nelson, C., and C. Plosser (1982). Trends and Random Walks in Macroeconomic Time Series: Some Evidence and Implications. Journal of Monetary Economics, 10: 130-62.

Odhiambo, N. M. (2005). Financial Liberalization and Financial Deepening: Evidence from Three Sub-Saharan African Countries. African Review of Money, Finance and Banking, (Saving and Development Supplement, 2005), 5-23.

Pattillo, C., Poirson, H. and Ricci, L. (2002). External Debt and Growth. IMF Working Paper 02/69, Internantional Monetary Fund: Washington.

Pattillo, C., Poirson, H. and Ricci, L. (2004). What are the Channels Through Which External Debt Affects Growht? IMF Working Paper 04/15, International Monetary Fund: Washington.

Rais, S. I. and T. Anwar (2012). Public Debt and Economic Growth in Pakistan: A Time Series Analysis from 1972 to 2010. Academic Research Journal, 2(1): 535-544.

Sachs, J. (1986). Managing the LDC Debt Crisis, Brookings Papers on Economic Activity, 2: 397-431.

Sachs, J. (1989). The Debt Overhang of Developing Countries. In Ronal Findley, ed., Debt, Growth and Stabilization: Essays in Memory of Carlos Diaz Alejandro, Oxford, Blackwell: U.K.

Shah, S. H., H. Hasnat, and L. J. Jiang (2012). Does Foreign Capital Inflows Really Stimulate Domestic Investment: A Case Study of Pakistan? International Research Journal of Finance and Economics, 85: 78-86.

Sheikh, M. R., M. Z. Faridi and K. Tariq (2010). Domestic Debt and Economic Growth in Pakistan: An Empirical Analysis. Pakistan Journal of Social Sciences, 30(2): 373-387.

Stoneman, C. (1975). Foreign Capital and Economic Growth. World Development, 3(1): 11-26.

Weisskopf, T. E. (1972). The Impact of Foreign Capital Inflow on Domestic Savings in Under Developed Countries. The Journal of International Economics, 2(1): 25-38. World Bank (2012). World Development Indicators, World Bank: Washington, D. C.

Yasmeen, K, A. Anjum, S. Ambreen, and S. Twakal (2011). The Impact of Worker’s Remittances on Private Investment and Total Consumption in Pakistan. International Journal of Accounting and Financial Reporting, 1(1):173-77.