DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN SOUTH ASIA: ANALYSIS OF ECONOMIC, INSTITUTIONAL AND POLITICAL FACTORS

Abstract

The growing importance of FDI among developing countries has led to a huge volume of empirical work on this topic. However, there is a dearth of research on factors that affect FDI to South Asia. Moreover, the existing studies on South Asia mostly focus on macroeconomic variables such as Gross Domestic Product (GDP), domestic capital formation, interest rate, real effective exchange rate, labour and trade openness and overlook the crucial role that institutions and political factors might play in determining FDI in South Asia. This paper attempts to understand the importance of various underlying determinants of FDI and using a dynamic panel data model for 1999-2013, argues that institutional and political factors are as important in determining FDI flows to South Asia as the conventional economic factors. The main findings of the paper are that countries with a large market size, stable macroeconomic environment, a higher level of existing FDI, a more liberal trading regime and lower country risk in terms of financial, economic, institutional and political stability are bound to attract more FDI. An understanding of such factors will enable policymakers of the South Asian countries to formulate and execute policies important for attracting FDI.