Impact of Foreign Direct Investment On Economic Growth in Pakistan

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Impact of Foreign Direct Investment on Economic Growth in Pakistan
Article · April 2021

DOI: 10.34218/IJM.12.4.2021.006
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International Journal of Management (IJM)
Volume 12, Issue 4, April 2021, pp.41-55, Article ID: IJM_12_04_006
Available online at http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=12&IType=4
ISSN Print: 0976-6502 and ISSN Online: 0976-6510
DOI: 10.34218/IJM.12.4.2021.006
© IAEME Publication Scopus Indexed
IMPACT OF FOREIGN DIRECT INVESTMENT

ON ECONOMIC GROWTH IN PAKISTAN
Komal Arain
Department of Statistics, Sindh Agriculture University, Tandojam, Pakistan
Naeem Ahmed Qureshi

Velo Suthar
Ali Akbar Pirzado*

Department of Statistics, Shaheed Benazir Bhutto University, Shaheed Benazirabad, Pakistan
Ahsan Hayat Khanzada

Ali Bux Baloch

Isra University, Hyderabad, Pakistan
Iftakhar Ahmed
Department of Economics, Lasbela University of Agriculture Water and Marine Sciences,
Uthal, Balochistan, Pakistan
Ahmed Khan Memon

*Corresponding Author
ABSTRACT
The present study was carried out to assess the impact of FDI (foreign direct
investment) on economic growth of Pakistan. The basic economic indicators (FDI,
GDP, CPI) were used to examine the relative growth using time series technique for 20
years of quarterly data i.e., 1997Q3 to 2017Q4). The ADF test was applied to check
the stationarity of time series using its three variants models i.e., model without
constant and trend; model with constant and no trend; and model with constant and
trend. All the time series were reported to be non-stationary at levels, however,
became stationary after taking second difference. The summary statistics revealed that
http://www.iaeme.com/IJM/index.asp 41 editor@iaeme.com
FDI, GDP and CPI during 1997 and 2017 remained in the range of US$ 50.605 and
116.788 billion, 11.767 and 701.300 billion, 37.525 and 154.830; reflecting exceptional
variability. The GDP growth was higher in 2005 (8.958%), 2016 (12.44%) and 2017
(17.75%); and least in 2009 (0.361%) and 2015 (0.12 %). The CPI in 1997 (37.29)
showed constant increase in the following years and highest (156.9) was in the 2017.
The estimated CPI in Pakistan may stand at 250.68 in coming 12 months’ time; while
in long term, the projected CPI trend may be around 263.00 points up to 2020.The
Granger Causality test was taken to know whether the variables granger cause or vice
versa. The results showed that FDI does not granger cause CPI at any leg value (since
its effects are not significant) and the effects of CPI on FDI are not significant at first
lag, however, these effects become significant of second and third lags respectively.
VAR (2) model was selected on the basis of SBIC criterion. The forecast clearly
indicates fluctuation in FDI, GDP and CPI and finally after 5-6 quarters, all the
forecasts were converged to unconditional mean of the data set.
Key words: Foreign Direct Investment, Economic Growth, Gross Domestic Product,
VAR.
Cite this Article: Komal Arain, Naeem Ahmed Qureshi, Velo Suthar, Ali Akbar
Pirzado, Ahsan Hayat Khanzada, Ali Bux Baloch, Iftakhar Ahmed and Ahmed Khan
Memon, Impact of Foreign Direct Investment on Economic Growth in Pakistan,
International Journal of Management (IJM), 12(4), 2021, pp. 41-55.
http://www.iaeme.com/IJM/issues.asp?JType=IJM&VType=12&IType=4
1. INTRODUCTION
The capital formation and the economic growth of a nation are influenced by numerous factors;
and these factors may vary among countries due to respective certain factors of primary
significance which mainly included geographical and geological situation; technological
progress, political stability and institutional structure. This study was performed to assess
association of economic development of the country with FDI (foreign direct investment) over
the period 1997˗2017. Globally, Pakistan is among the countries with developing economies
and considered 25th largest economy in terms of PPP (purchasing power parity), and 42nd in
terms of nominal GDP (gross domestic product). By population, Pakistan ranks 5th in the world
with 207 million heads. The per capita nominal of Pakistan was US$ 1,641 in 2018 ranks 147th
in the world. Although, Pakistan is among developing nations at present, but one of the eleven
nations (Next Eleven) having potential to become among the large economies of the world in
the 21st century. In 1960’s Pakistan was among the economically strong economies of the world
and once Pakistan gave US$ 4 million to Japan for development of agricultural economy.
However, political and social instability in the country and decades of war in the region, serious
deficiencies developed in the basic services such as railway transportation and power
generation. At present, Pakistan is experiencing economic liberalization process which mainly
included privatization of corporations under public sector, mainly aimed at attracting foreign
investment and reducing budget deficits (Wikipedia, 2018). According to the World Bank
assessment, the economy of Pakistan will grow at a "robust" rate of 5.4 percent by 2018, due to
improved foreign investment inflow mainly from the China-Pakistan Economic Corridor. FDI
is a type of investment that entails inflow or the funds received from an investor for investment
from one country into another country of the world (Tsai, 2010; Al-Rawashdeh et al., 2011).
The factor that accelerates economic growth in a country mainly includes the foreign direct
investment which is leading aspect for enhancing growth of an economy, generates
employment, creates opportunities for the professionally skilled local manpower, creates
opportunities to utilize technological and managerial skills, constraints of balance of payments
Komal Arain, Naeem Ahmed Qureshi, Velo Suthar, Ali Akbar Pirzado, Ahsan Hayat Khanzada,
Ali Bux Baloch, Iftakhar Ahmed and Ahmed Khan Memon
is removed, help to promote exports, develops a competitive business environment and

numerous other progressive outputs that distinguish such kind of funding from different other
monetary sources. Foreign direct investments are of different types which mainly included
inward foreign direct investments which included the investment in local resources with foreign
capital. However, the main feature that could enhance inflow of inward foreign direct
investments includes tax breaks, lower interest rates and grants. Another is the outward foreign
direct investments also termed as Direct Investment Abroad (Anupama and Rupashree, 2019).
In novel terms, foreign direct investment is generally classified either as horizontal, vertical or
conglomerate. In horizontal FDI, the investor establishes same trade operation in another
country as operates in its home country; while in vertical investment the investor operates some
different business activity in a foreign country but related to investor's main business activity
in its home country. On the other hand, in conglomerate foreign direct investment, the investor
makes foreign investment that is not related to its existing business in its home country (Chen,
2019). Since Pakistan has developing economy and categorized by low income level, deficient
in capital, low industrialization level, weaker saving, rapid population growth, huge external
debt burden, do not have foreign aid, deficient balance of payments, least exploitation of
managerial, technical and technological skills, and primarily relies on export to cope up with
the essentially required goods. There are inadequate resources domestically to cater ever
increasing needs; hence foreign direct investment is a vital instrument to overcome the
weaknesses constraining economic development (Muhammad and Khattak, 2009). According
to the World Bank (2002) in 1997 developing countries received 36 percent of the total FDI
flows; there has been positive association of FDI with GDP of the host nations. De Mello (1999)
proved FDI as most importance factor in improving economic growth and the development
industrial projects developed skilled labor and significantly positive impact on country’s
economic activity (Musila and Segue, 2006). The GDP of the developing nations receiving FDI
was found improving due to improved productivity and created business competition in the at
national level (Le and Ataullah, 2006). Chakraborty and Nunnenkamp (2008) argued that FDI
structure composition is essential for economic growth in a developing country. In 1990s, the
government in Pakistan started giving tax incentives, fiscal benefits and reduced tariff for FDI
attraction (Aqeel and Nishat, 2004); and 100 percent equity in industrial projects to the foreign
investors was offered without approval of the competent forums prior to its implementation
(Khan, 2008). In the fiscal year 1994, restrictions to some extent were eased on certain capital
transactions and outward investment (Khan, 2008). Pakistan has bright prospective for
commencement of foreign investment; and obvious FDI volume impacts the policy success; but
corruption, poor law, weaker regulatory system, political uncertainty, institutional weaknesses,
ineffective legal institutions, law and order situation and weak regulatory systems have
obstructed the FDI inflows in Pakistan (Khan and Khan, 2011). There are numerous challenges
to Pakistan's economy due to poverty and unemployment problems due to lack of funding for
mega economic projects that could help to create appropriate situation for promotion of
industrial linkages. The point of consideration as evident from statistics is that there is greater
impact of FDI in the open trade policy regimes (Iqbal, 2014). Waqas Javaid (2016) used ARDL-
ECM model to examine the impact of FDI on economic growth of Pakistan and concluded that
FDI had not only positively and significantly affected the growth in GDP of the country but
also influenced the inflation rate. Besides, the population growth influences in significant
manner to the GDP. On the other side, the trade and gross capital had insignificant role to
elucidate variation in the growth of national economy. Siddique et al. (2017) indicated
unidirectional causality from economic growth to FDI, to physical capital and to trade and study
suggested adoption of policies that may enhance human skills to attract more FDI for economic
growth. Anupama and Rupashree (2019) used ARIMA to forecast the impact of FDI inflow
suggested that the Government must take some special care in framing policies and procedures
which would enable the investors of other nations to invest into our economy in various possible
sectors which will thereby boost the economic growth of the nation in all positive aspects.
Considering the aforementioned hypotheses, this study was carried out to examine FDI impact
on economic growth in Pakistan.
• To find the determinants of foreign direct investment in Pakistan.
• To check the impact of FDI on economic growth (i.e., GDP and Inflation) in Pakistan.
2. MATERIAL AND METHODS

There are several tests available to check whether the time series is stationary such as Dickey
Fuller (DF) test, Augmented Dickey Fuller (ADF) test, Phillips Parron (PP) test, and
Kwiatkowski–Phillips–Schmidt–Shin (KPSS) test. Among them, the most popular is the
Dickey Fuller test and its extended version which is called as “Augmented Dickey Fuller”
(ADF) test. Due to a wide range of its applicability, in our analysis, we will use ADF test which
is described as under:
2.1 The Vector Auto-regressive (VAR) Model

The Keynesian model estimation developed into extensive synchronized models with large
number of variables in certain instances. Criticism to Keynesian model on hypothetical and
pragmatic grounds started in 1970s. Here an approach is discussed that is called VAR (Vector
Auto-regressive) model, which is time and again observed as alternative approach to
instantaneous equation approach.
The evolution of a set of k variables (endogenous variables) is described by VAR model
over same period (t =1,...,T) as a linear function related to their precedent values.
A k × 1 vector𝑦𝑡 collect variables that possessed the i th element, 𝑦𝑖,𝑡 observation at time "t" of
i th variable. A pth order VAR, denotes VAR (p), is
𝑦𝑡 = 𝑐 + 𝐴𝑡 𝑦𝑡−1 + 𝐴𝑡 𝑦𝑡−2 + ⋯ + 𝐴𝑝 𝑦𝑡−𝑝 + 𝑒𝑖 ,
where the observation 𝑦𝑡−𝑖 (i periods back) is said as ith lag of y, c is a k×1 vector of
constants, 𝐴𝑖 is time invariant k×k matrix and et is a k×1 vector of error term as satisfying:
• 𝐸 (𝑒𝑡 ) = 0 which means each error term has mean zero;
• 𝐸 (𝑒𝑡 𝑒𝑡′ ) = Ω which means the contemporary covariance matrix of error term is
Ω (k×k positive-semi-define matrix);
• 𝐸 (𝑒𝑡 𝑒𝑡−𝑘′ )
= 0 i.e., for non zero k-there is no relationship across time; no serial
correlation in individual error term.
2.2 Ljung-Box Test

T (T + 2) m=1 pek (m)
M
QMK =
T −m
  
pe (1) = pe (2) = ........ = pe (m) = 0
H0;
 
pe (1),...... pe (m)  0,
HA;
2.3 MSFE (Mean Square Forecast Error)

n 2
 ( y − yˆ ) t t
MSFE = t =1
n
2.3.1 RMSFE (Root Mean Square Forecast Error)

n 2
 ( y − yˆ ) t t
RMSFE = t =1
n
1 n
yt − yˆt
MSPE = 100 
n
 t =1 yt
Table 1 Out-of-sample forecast evaluation criteria

Fit statistics Expression Remark
Mean Square Forecast Error n 2
Relatively Low
( y
t =1
t − yˆt )
n
Root Mean Square Forecast n 2
Relatively low
Error(RMSFE) ( y t
ˆt )
−y
RMSFE = t =1
n
Mean Absolute Percentage 1 n
yt − yˆt Minimum
Error(MAPE) 100  
n t =1 yt
Akaike Information Criterion (AIC) n+k Minimum
ln  k2 +
n−k −2
Bayesian Information Criterion (BIC) k ln ( n ) Minimum
ln  k2 +
n
Hannan-Quinn Information Criterion 𝐻𝑄𝐶 Minimum
(HQC) = −2𝐿𝑚𝑎𝑥 + 2𝑘 ln(ln( 𝑛) )
3. RESULTS
Figure 1 shows that time series plot of FDI and FDI growth rate for a period of 20 years from
1st July 2000 to 30th December 2020. It can be clearly observed that the FDI increases and
decreases due to many reasons. The illustration of FDI in figure 1 depicts that FDI inflow in
the years 2004 and 2005 touched a climax of 6.5 billion as the FDI inflow in the year 2001 and
2002 was only 2.5 billion. However, after 2005, the FDI inflow started declining and upto the
2013, the FDI came to lowest inflow of 3.0 billion. The government during 2008 and 2013
could not effectively manage this sector and experienced rapid decline in FDI inflow due to
ineffective policies. However, the new regime after general election 2013 in Pakistan formed
effective policies and FDI inflow and FDI inflow in Pakistan reached at 6.0 billion in 2015; and
up to the end year 2020, the FDI inflow showed stability but yet in comparative lower side. The
FDI flow into Pakistan is insignificant against the available opportunities and economic
potentials of the country. Political instability, followed by deteriorated law and order situation
seemed to have considerable adverse effect on the FDI inflow into Pakistan. Moreover,
alarming level of corruption and crisis in energy sector also caused unfavorable environment
for FDI inflow into the country. These factors did not allow developing required level of
infrastructure, poor enforcement of contracts, and decreased share of credit to non-government

sectors and higher rates of corporate taxes. Figure 1 also reflects the FDI growth rate (1st July
2000 to 30th December 2020) suggesting a highly variable periodical FDI inflow into Pakistan.
The quarterly FDI showed a high inconsistency that reflects the corresponding inefficiency in
case of the government policies that could not attract FDI even under internationally accepted
democratic system. However, during 2013 and 2014 quarterly variation was exceptionally high.
Trend analysis of FDI is illustrated in figure 1.
Figure 1 FDI and its Growth Rate, Pakistan 2000-2020 (Quarterly)
3.1 GDP and GDP growth

The gross domestic product or GDP is common indicator to gauge economic health of a nation;
and it mainly includes the factors related to consumption and investment. The GDP represents
total value of goods and services produced during a year; and generally it is known as size of
economy. The economist uses GDP to assess the economic growth; while the investor makes
investment decision on the basis of size of economy and GDP growth. The GDP is logically
calculated on the basis of what has earned by everyone and what has spent by everyone in a
year.
The figure 2 depicts real GDP and GDP growth rate in Pakistan during last two decades
(2000 to 2020). It is evident from the figure plotted for GDP that the GDP growth on constant
price in Pakistan was least (1.703%) in 2000, which increased to 3.404, 4.184 and 3.906 in the
years 2000, 2002 and 2003, but declined sharply in 2004(1.967%). However, the GDP growth
rate later took off and reached 8.958 percent in the year 2007 and later started decreasing at
gradual pace; and reached history lowest growth rate (0.361%) in the year 2011. This was the
period when General Parvez Musharaf’s regime was over after PPP led government impeached
her to decline as President, Islamic Republic of Pakistan. Later, apart from the super floods in
2013, the economy somehow started stabilizing growth (3.696 %) upto 2016 when the PML
(N) led assembly took over especially in 2017, 10.05 percent GDP growth was observed, but
crashed in the following year 2017 (0.12 %). This history lowest GDP rate might be explained
by deteriorating law and order situation in the country and severe political instability. The years
2019 and 2020 remained much promising with 12.44 and 17.75 percent growth in the GDP.
This increase in the GDP after 2018 can be explained by government effort and policies adopted
and implemented related to economic development. Furthermore there was great success and
improvement in the law and order situation in the country that also added significantly to
increase GDP. The growth targets are generally set higher over the preceding fiscal year; the
reasons of setting such higher growth target over the preceding year are associated with tax
legislation, trade reforms, privatization; certain reforms in the financial sector, development in
the human resource sector and social protection measure. Pakistan in the recent past has
undergone critical changes so far the political and constitutional sphere are concerned.
However, the economic growth is being supported by civil societies and other associated
organizations and they also noted committed to have a significant and positive role with
government reforms to help economic growth.
The GDP was significantly increased, particularly after 2005. This increase in the GDP after
2005 can be elucidated by the policies and efforts of the Pakistan government. The policies
might have attracted the local investment and the improved tax collection policies and the
effective implementation of the policies related to the economic development. The per annum
GDP growth showed inconsistency during the period of study (20 years) and growth rate seems
to be lower than the potentials.
Figure 2 GDP and its Growth Rate, Pakistan 2000-2020 (Quarterly)
3.2 CPI and CPI growth

CPI (Consumer price index) imitates the change in cost paid by average consumers for
purchasing goods and services that can be set or changed at specific time interval such as
quarterly, biyearly or yearly. The figure 3 reveals the time series plot for CPI and CPI growth
rate (percentage) over a two decades’ period (2000 to 2020). It is observable that CPI has
constantly following an increasing trend during the last two decades. The CPI illustration
depicts that in the year 2000 the CPI was computed at 37.29 that reflected rise to 39.61 (2001),
41.25 (2002), 43.05 (2003), 44.41 (2004), 45.87 (2005), 47.21 (2006), 50.72 (2007), 55.32
(2008), 59.64 (2009) and 64.24 (2010). However, afterwards, CPI followed a rapid increase
year of year and consumer price index of 77.27 (2011), 87.81 (2012), 100 (2013), 111.92
(2014), 122.76 (2015), 132.20 (2016), 141.70 (2017), 145.30 (2018) and 150.75 (2019); while
in the year 2020 the consumer price index was 156.9.
The growth rate of CPI in the year 2000 was 11.4 percent, while CPI growth year of year
was 6.2 (2001), 4.1 (2002), 4.4 (2003), 3.1 (2004), 3.3 (2005) and 2.9 (2006) percent; which
later increased greatly to 7.4 (2007), 9.1 (2008), 7.9 (2009), 7.6 (2010) and 20.3 percent in the
year 2011. In the following years, the CPI followed a decline i.e. 13.6 (2012), 13.9 (2013), 11.9
(2014), 9.7 (2012), 7.7 (2015), 7.2 (2016) and least 2.15 (2017). In 2018, the CPI growth
remained 3.8 percent and further increased to 4.1 percent in the year 2020. The CPI in 2011
recorded a high over the preceding year 2012 that show a vertical change impact on the
consumer. increase in inflation was associated with many factors which mainly include
withdrawal of subsidy on petroleum and gas and rationalized electricity tariff, depreciated rupee
value against US dollar, imported inflation, high borrowing of government from State Bank
against fiscal deficit, increased support price of sugarcane and wheat, political instability and
super floods in the year 2013. Hundreds of thousands acres came under this calamity across the
country and the farmland was ruined. Due to heavy damage to the agriculture crops, the food
prices were increased and subsequently the increased inflation was observed. On the basis of
the CPI during last two decades, the estimated CPI in Pakistan may stand at 250.68 in coming
12 months’ time; while in long term, the projected CPI trend may be around 263.00 Points up
to 2020 as described by the econometric models used in this study.
Figure 3 Inflation (CPI) and its Growth Rate, Pakistan 2000-2020 (Quarterly) Plot of CPI for
historical data: 2000-2020(Quarterly)
Table 1 Lag order selection for VAR (p) model

Lag LL AIC SBIC Ljung Box Test
VAR(0) -1164.433 28.47397 28.56202 224.40 (0.000)**
VAR(1) -655.0283 16.46983 16.82457 116.95 (0.005)**
VAR(2) -615.3038 15.90759 16.53288 83.683 (0.163)
VAR(3) -598.9074 15.92171 16.82150 70.17 (0.250)
VAR(4) -572.2773 15.67378 16.85213 61.65(0.221)
LL= Log Liklihood, AIC=Akaikes information critera, BIC=Byesin information criteria
Table 2 Results of Pairwise Granger Causality Test

Lags:1 Obs:79 Lags:2 Obs:78 Lags:3 Obs:77
Null Hypothesis: F-Stat. Prob. F-Stat. Prob. F-Stat. Prob.
FDI does not Granger Cause CPI 1.652 0.199 2.169 0.338 5.959 0.114
CPI does not Granger Cause FDI 0.193 0.661 9.010 0.011* 15.609 0.001**
FDI does not Granger Cause GDP 6.067 0.014* 4.855 0.088 9.965 0.019*
GDP does not Granger Cause FDI 2.967 0.085 2.633 0.268 1.443 0.696
CPI does not Granger Cause GDP 0.822 0.365 9.999 0.007** 19.901 0.000**
GDP does not Granger Cause CPI 0.028 0.867 0.089 0.957 15.921 0.001**
Note: * &** represent the rejection of null hypothesis at 0.05 and 0.01 level of significance,
respectively
3.3 VAR estimation (Vector Autoregression Estimates)

The VAR model was applied to find out interrelationship among the variables; and the VAR
estimation results from the present study are demonstrated in Table 1. The results presented in
Table 2 show that the coefficients of lagged CPI and GDP were significant in FDI and CPI
regressions; while the constant was insignificant for FDI, CPI and GDP. All coefficients in
regression of the GDP are insignificant and statistically the difference remained zero.
Forecasting is performed for all variables where we have at least one explanatory variable
significant, the variables forecasted are GDP, CPI and FDI. The coefficient of determination
(r2) suggested that 99.9 percent of the change in CPI and GDP was associated with the change
in the FDI.
Table 3 Estimation Result of VAR (2) model

Vector Autoregression Estimates
Sample (adjusted): 3 82
Included observations: 80 after adjustments
Standard errors in ( ) & t-statistics in [ ]
FDI CPI GDP1
FDI(-1) 0.105163 -0.001088 -0.000798

(0.10835) (0.00135) (0.00040)
[ 0.97058] [-0.80536] [-1.99594]
FDI(-2) 0.363632 -0.001178 0.000140

(0.11140) (0.00139) (0.00041)
[ 3.26432] [-0.84773] [ 0.33986]
CPI(-1) -13.01206 1.403041 -0.051702

(8.33356) (0.10393) (0.03074)
[-1.56140] [ 13.4995] [-1.68179]
CPI(-2) 8.739552 -0.448445 0.045077

(8.09783) (0.10099) (0.02987)
[ 1.07925] [-4.44037] [ 1.50897]
GDP1(-1) 53.94937 -0.345600 1.582307

(27.0247) (0.33704) (0.09969)
[ 1.99630] [-1.02540] [ 15.8717]
GDP1(-2) -43.46052 0.462761 -0.563141

(28.3357) (0.35339) (0.10453)
[-1.53377] [ 1.30949] [-5.38738]
C -404.7669 -3.982114 -0.436489

(139.559) (1.74053) (0.51483)
[-2.90032] [-2.28788] [-0.84783]
R-squared 0.658283 0.999293 0.999728

Adj. R-squared 0.630197 0.999235 0.999705
Sum sq. resids 617868.8 96.10364 8.408302
S.E. equation 91.99976 1.147383 0.339385

F-statistic 23.43785 17205.74 44643.20
Log likelihood -471.5953 -120.8511 -23.40280
Akaike AIC 11.96488 3.196278 0.760070
Schwarz SC 12.17331 3.404705 0.968497
Mean dependent 182.3841 85.68502 81.02040
S.D. dependent 151.2869 41.49165 19.76476
Determinant resid covariance (dofadj.) 1266.059

Determinant resid covariance 961.9502
Log likelihood -615.3038
Akaike information criterion 15.90759
Schwarz criterion 16.53288
Number of coefficients 21
4. FORECAST EVALUATION
For the evaluation purpose, Mean Square Forecast Error (MSEF), Root Mean Square Forecast
Error (RMFSE), and Mean Absolute Percentage Error (MAPE) were used. The following table
compare the validation of all three variables that which variable is a good for forecasting it is
based on small value of RMSFE that is for GDP.
Table 4
Sample: 1 80
Included observations: 80
Variable Inc. obs. RMSFE F

MAE MAPE
CPI 80 0.013299 0.009844 5387.750

FDI 80 1.350266 1.017366 20911.36
GDP 80 0.004092 0.002467 4725.944
RMSE: Root Mean Square Error

MAE: Mean Absolute Error
MAPE: Mean Absolute Percentage Error
The above table reflects the comparison of all variables, that which variable is good for
forecasting. It is based on small value of RMSE that is for GDP. In order to describe the
forecasting values, upward and downward bias terms were used. The model for clearly reflects
the upward trend of forecast values of FDI than the observed values; while observed values of
GDP for 2020 onward followed upward trend markedly greater than the observed values of
GDP. Similarly, for CPI the observed values are higher than the forecast values. The selected
model clearly indicates that forecast values for FDI and GDP are greater than observed values
that describe that the model illustrates upward trend for FDI and GDP in future. However, the
observed value seems to be greater than the forecast value for CPI which reflects that in future
the CPI may decrease. There may be under prediction for the FDI, CPI and GDP. The
differences between actual and predicted FDI, CPI and GDP might be associated with the
policies adopted by Government of Pakistan for the promotion of FDI, CPI and GDP. The
disparity of actual and predicted values might also be associated with the steps taken by the
Pakistan government to improve their GDP in all economic sectors and provide facilitation to
investors for attracting foreign and domestic investments. However, weaker GDP and increased
CPI forecasts are mainly associated with alarming level of corruption, lack of motivation among
the stakeholders and poor foreign office policies and international relations.
Figure 4 Quarterly observed and forecasted values for FDI, GDP and CPI used in the models
The graph explains that FDI inflow in Pakistan fluctuated upward and downward and in
2005 FDI inflow showed a decline but maintained upward position. However, after 2008-2009
onwards the FDI inflow showed regularity in each quarter upto 2014; but later, a high
fluctuation could be seen explaining severe uncertainty in case of FDI inflow upto 2017-2018
but then stability could be seen upto 2020. On the basis of 2000 to 2020 data regarding FDI
inflow, the forecasting for next five years (2021-20225 the graph clearly indicates downward
and upward trend in case of FDI inflow upto the year 2021 and later it turns to unconditional
momentum. The figure 4 further explains that CPI also had upward and downward variation
upto the year 2010, but the upward and downward fluctuation was extraordinary in next two
years, and the fluctuation sustained upto the year 2019 and then became normal. The forecast
indicates that initially in 2021-22 there will be following slight downward and upward move in
CPI, but later it will be unconditional (2021-2025).The GDP forecast suggested a normal
upward and downward trend in each quarter upto the year 2013, but later static condition could
be seen upto the year 2019. However, in 2020 there was more downward fluctuation then the
upward move of GDP. The plot forecasts that initially in 2021 there will be an upward trend in
GDP, but later it will be unconditional (2021-2025). Multiple things are involved in output
drive which generally included oil prices, fiscal policy and interest rates etc. The unconditional
forecast suggests what output will certainly be at some date; while conditional forecast explains
that there may happen something to output if rate of interest is changed; so in this case only
change in interest rates. The unconditional forecast is difficult as the analyst needs to catch an
entire host of relevant aspects right. The unconditional forecast describes what the ‘Y’ will be
under the forecast of all ‘X’ variables influencing ‘Y’ (Simon Wren-Lewis, 2016).
Figure 5 Forecasting of FDI, GDP and CPI on the basis 20 years’ data (2000-2020)
5. CONCLUSION
• During 2000 and 2020, FDI was in the range of US$ 50.605 and 116.788 billion, GDP
11.767 and 701.300 billion, CPI 37.525 and 154.830; reflecting greater variability.
• The time series analysis depicts that FDI inflow in the years 2007 and 2008 touched a
climax, but later started to decline and deterioration continued up to 2016; but later
showed stability up to 2020.
• The quarterly FDI growth showed a high inconsistency that reflects the corresponding
inefficiency in case of the government policies that could not attract FDI even under
internationally accepted democratic system; in 2016 and 2017 quarterly variation was
exceptionally high.
• The GDP growth was higher in 2008 (8.958%), 2019 (12.44%) and 2020 (17.75%); and
least in 2012 (0.361%) and 2018 (0.12 %).
• The collapsed GDP growth could be linked with deteriorating law and order situation,
terrorism and severe political instability in the country; while stability in GDP in 2019
and 2020 might be the fruit of Zarb e Azb that improved law and order situation in the
country and gained the confidence of business community hence significant increase in
the GDP.
• The CPI in 2000 (37.29) showed constant increase in the following years and highest
(156.9) was in the 2020.
• The estimated CPI in Pakistan may stand at 250.68 in coming 12 months’ time; while
in long term, the projected CPI trend may be around 263.00 points up to 2020.
• The FDI had varied impact on GDP and CPI at different lags and suggested that one
standard deviation in FDI had a favorable impact on GDP growth after one year in
future.
• There was positive and negative FDI and GDP incline towards increase and decrease
returns on CPI but dynamic impact of positive GDP shock vanishes after four weeks.
The impact is always positive and high for first two lags, decays later fast and become
non-significant after third or fourth lag.
• The FDI, CPI and GDP on the level series did not reveal stationarity in most cases in all
three models; and on first difference all series showed stationarity (P<0.01) in all three
models except model-1; while on the second difference the ADF suggested that FDI,
CPI and GDP showed stationarity in all three models.
• The LL selected the VAR (2) model; while AIC and SBIC, both are the information
criteria selected VAR (4) model.
• There is no unidirectional causality from FDI to CPI and GDP to FDI at all lags
(Independent).
• Null hypothesis for CPI to FDI was rejected at lag-2 (0.05 sig) and lag-3 (0.01 sig);
unidirectional causality from FDI to GDP at lag-1 (0.05 sig) and lag-3 (0.05 sig); CPI
to GDP at lag-2 and lag-3 (0.01 sig) and for GDP to CPI at lag-3 (0.01 sig).
• The coefficient of determination (r2) suggested that 99.9 percent of the change in CPI
and GDP was guided by the change in the FDI.
• FDI inflow will fluctuate in the year 2021 downward and upward in different quarters
and later it will turn to unconditional.
• The CPI initially in 2021-22 will be showing slight downward and upward move, but
later it will be unconditional.
• The GDP initially in 2021 will follow upward trend, but later it will be unconditional
(2021-2025).
RECOMMENDATIONS:
• It is suggested that different Government policies should be introduced that boost
human skills to attract more FDI for economic development.
• The selected models (VAR) can be used to predict the future fluctuations in GDP, CPI
and FDI.
• To reduce the gap in FDI inflows between Pakistan and other developed countries,
Pakistan needs to liberalize its foreign Investment policy framework in a broader way.
• The government should also focus on the infrastructure so that it can also help in
increasing the economic growth of the country.
• Finally, it is suggested that government must ensure the inflow of quality rather than its
magnitude.
• It is required to change Pakistan’s development strategy in order to reap the full benefits
of FDI inflows.
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Impact of Foreign Direct Investment on Economic Growth in Pakistan

Article · April 2021

Naeem Ahmed Qureshi Ali Akbar Pirzado

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IMPACT OF FOREIGN DIRECT INVESTMENT

Naeem Ahmed Qureshi

Ali Akbar Pirzado*

Ahsan Hayat Khanzada

Ali Bux Baloch

Ahmed Khan Memon

is removed, help to promote exports, develops a competitive business environment and

2. MATERIAL AND METHODS

2.1 The Vector Auto-regressive (VAR) Model

2.2 Ljung-Box Test

2.3 MSFE (Mean Square Forecast Error)

2.3.1 RMSFE (Root Mean Square Forecast Error)

Table 1 Out-of-sample forecast evaluation criteria

infrastructure, poor enforcement of contracts, and decreased share of credit to non-government

Figure 1 FDI and its Growth Rate, Pakistan 2000-2020 (Quarterly)

3.1 GDP and GDP growth

Figure 2 GDP and its Growth Rate, Pakistan 2000-2020 (Quarterly)

3.2 CPI and CPI growth

Table 1 Lag order selection for VAR (p) model

Table 2 Results of Pairwise Granger Causality Test

3.3 VAR estimation (Vector Autoregression Estimates)

Table 3 Estimation Result of VAR (2) model

FDI CPI GDP1

FDI(-1) 0.105163 -0.001088 -0.000798

FDI(-2) 0.363632 -0.001178 0.000140

CPI(-1) -13.01206 1.403041 -0.051702

CPI(-2) 8.739552 -0.448445 0.045077

GDP1(-1) 53.94937 -0.345600 1.582307

GDP1(-2) -43.46052 0.462761 -0.563141

C -404.7669 -3.982114 -0.436489

R-squared 0.658283 0.999293 0.999728

S.E. equation 91.99976 1.147383 0.339385

Determinant resid covariance (dofadj.) 1266.059

Variable Inc. obs. RMSFE F

CPI 80 0.013299 0.009844 5387.750

RMSE: Root Mean Square Error

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