Causality analysis of the determinants of FDI in Bangladesh: fresh evidence from VAR, VECM and Granger causality approach

Abstract

We tested the causality between FDI and its determinants in Bangladesh in the presence of structural break harnessing Vector Autoregression (VAR) model and Granger causality test. Regressors such as GDP growth rate, inflation, interest, corporate tax, exchange and wage rate, and trade openness (TO) have been used. VAR model finds that interest, tax, wage, and exchange rate do not affect inward FDI. However, the inflation rate and TO significantly impact the inward FDI in Bangladesh. The Granger causality test reveals a bidirectional causality in the FDIinflation and FDI-TO nexus, whereas other explanatory variables do not cause the FDI granger. Variance decomposition (VDC) and impulse response function (IRF) assessment approve strong, moderate, and poor or no explanatory power of TO, inflation, and other explanatory variables, respectively. Regarding FDI-inflation bidirectional causality, we observed both natural (inflation truly causes FDI) and fake causality (FDI does not necessarily cause inflation). Therefore, when inflation causes FDI, then Bangladeshi Taka (BDT) becomes strong against USD, which increases import and reduces export (import > export). Due to the negative trade balance, this is true for Bangladesh. However, if FDI causes inflation, it will depreciate BDT; consequently, the export will surpass the total import, which is not the case in Bangladesh. Therefore, inflation causes FDI in Bangladesh, and this punch line ends the ongoing debate in the FDI-inflation-exchange rate nexus in Bangladesh. Finally, we recommend decreasing the lending interest rates to encourage further investment, adopting tax holidays, developing a skilled and semi-skilled workforce to harness the advantage of lower wage rates, and being more open to facilitating FDI-led development.

Determinants that attract and discourage foreign direct investment in GCC countries: Do macroeconomic and environmental factors matter?

“…A positive and highly significant long-run relationship between FDI and INFL is both theoretically and practically acceptable. This study has confirmed this relationship, which aligns with the recent findings obtained by [ 31 , 55 , 60 ] in the cases of Bangladesh, G20 countries, and oil-exporting countries (OPEC), respectively. Other studies by [ 43 , 54 , 63 ], have also observed that higher inflation rates attract more FDIs in BRICS and CIVETS, BRICS, and African countries, respectively.…”

“…Our empirical finding of a positive and highly significant (p ≤ 0.01) long-run relationship between FDI and inflation in the case of GCC countries is consistent with the results of [ 30 , 31 , 55 , 60 – 62 ]. The phenomenon of higher inflation with higher inward FDI is widely accepted across countries, be they developing, emerging, or developed.…”

“…However, in the literature review, we can see three different results regarding this relationship. Some studies observed a significant and positive relationship between FDI and CPI indices [31,55,[60][61][62]. [60] conducted a study analyzing the factors affecting FDI in Bangladesh for the period 1975-2015.…”

“…Some studies observed a significant and positive relationship between FDI and CPI indices [31,55,[60][61][62]. [60] conducted a study analyzing the factors affecting FDI in Bangladesh for the period 1975-2015. This study points out that foreign investors prefer to invest more when inflation rates are higher.…”

Factors Affecting Foreign Direct Investment: The Case of the Netherlands

“…Foreign direct investment numbers have developed emphatically as a significant type of worldwide capital exchange over the many previous years. It is the most important economic indicator and critical component for a country's financial health and addresses a vital cause of funding capital speculation (Morshed et al, 2022). Additionally, it similarly assurances strength, as the "cold" FDI streams are viewed by way of a steadier wellspring of external financing due to its long-term stay in a country than "hot" portfolio investment treated as short period and a sentence always used for hot money is "hot money burns economy."…”