ECONOMIC PAPERS, VOL.

, NO.

,

, 1–18

Special Section: Understanding Indonesia’s Economic and

Financial System

Impacts of FDI and Remittance Inflows in

Developing Asia: A Comparative Dynamic
Panel Study*
Madhabendra Sinha,1 Darius Tirtosuharto2 and Partha Pratim Sengupta1

The paper explores the macroeconomic impacts of foreign direct investment

(FDI) and remittance inflows in developing Asia. Asian developing econo-
mies are identified as the highest receiver of remittances and the region has
also been consistently performing well in receiving of FDI inflows. As an
external source of capital formation, inflows of FDI and remittances affect
foreign exchange rates and output. This study provides empirical evidence on
the impact of FDI and remittances on real effective exchange rates and GDP
in Asian developing countries using data over the period of 1981-2015.
Dynamic panel GMM technique is employed to overcome the endogeneity
issue. Findings imply that both inflows of FDI and remittances have positive
and significant impacts on exchange rates and GDP in developing Asia.
Hence, remittances carry greater influence and significant impacts due to
relatively stable inflows.
Keywords: FDI, remittance, economic growth, exchange rate, developing
Asia, dynamic panel, GMM.

1. Introduction
Inflows of foreign direct investment (FDI) and migrants’ remittances from abroad play an instrumen-
tal role in the economic performances of a country. FDI inflows and remittances enable a country to
finance investment, accelerate the process of capital formation and stimulate economic growth. These

*The views expressed in the paper are those of the authors and not necessarily those of the institution to which
they belong. The authors thank three anonymous referees of the paper and the editor of the journal for their kind
and helpful comments. Several comments from the respective session chair, discussant and participants of the
Bank Indonesia and Asia-Pacific Applied Economics Association International Conference held at Bali, Indonesia
on 30–31 August 2018, where an earlier version of the paper was presented, are gratefully acknowledged. The
authors also thank the kind support from the conference organisers. There is no conflict of interest. Useful dis-
claimers apply.
1
Department of Humanities and Social Sciences, National Institute of Technology Durgapur, West Bengal, India.
2
Economic and Monetary Policy Department, Bank Indonesia, Jakarta, Indonesia.
JEL classifications: F21, F24, F31
Correspondence: Darius Tirtosuharto, Economic and Monetary Policy Department, Bank Indonesia, Jakarta,
Indonesia. Email: dtirtosuharto@bi.go.id
Accepted date: June 9, 2019

1
Ó 2019 The Economic Society of Australia
doi: 10.1111/1759-3441.12260
2 ECONOMIC PAPERS

inflows carry advanced technologies, improved infrastructures and new employment opportunities,
which help domestic producers gain the advantages of knowledge and technologies along with
increased productivity. A number of economic theories corroborate the contribution of capital
inflows to economic activities through various channels and regions within different time spans.
From the demand side, capital inflows will support a smoother path of consumption, which is crucial
considering consumption has the largest share in many developing economies.
Foreign direct investment and remittance inflows also directly correlated with real exchange rates
through supply and dynamic in the foreign exchange market. In a flexible exchange rate regime, capital
inflows will increase demand for domestic currency, which results in the appreciation of the nominal
exchange rate. Assuming there is rigidity in prices, the real exchange rate will also appreciate. This
could potentially increase aggregate demand with higher consumption due to higher receivable export
incomes and investments. Hence, currency appreciation may eventually lower export competitiveness
and induce higher imports if there is a lack of capacities and capabilities in domestic production.
The declining trends of worldwide FDI flow unveil the regional variations. FDI grew at the highest
level in 2015 since the global financial crisis (GFC) 2008–2009. However, most of the increase was
driven by the cross-border mergers and acquisitions and corporate reconfigurations (United Nations
Conference on Trade and Development (UNCTAD), 2016). With lower aggregate global demand due
to slower growth in the commodity producer countries and China rebalancing, global FDI has actu-
ally been muted until now. Despite the gradual economic recovery, FDI inflows have tipped into the
developed economies in 2015 with a total share of 55 per cent. Meanwhile, FDI inflows to the devel-
oping economies only grew at a single-digit growth rate and the majority of this inflow went to devel-
oping Asia (almost 70 per cent in 2015). Another feature of the global FDI after the end of the
commodity boom was the weakening of FDI activity in the primary sector.
As a countercyclical measure to respond to declining FDI, many developing Asian nations have
been introducing various economic reforms, particularly on the supply side. Improving the quantity
and quality of public infrastructures is considered crucial to be able to compete in attracting FDI in
strategic sectors. However, for many developing countries in the Asian region, financing public capi-
tal investments is a challenge especially for countries with a current account deficit. This is worsened
by the fact that a lot of infrastructure investments require high-tech imports that drive deficit trade
balance and lower GDP. Consequently, this will also put pressure on the exchange rate as current
account deficits widen without any additional sources of external financing from either portfolio
inflow, remittances, tourism revenue or other services export.
The inflow of remittances is another major source of capital inflows for many developing countries.
These inflows benefit the economy through an increase in domestic consumption as a source of GDP
growth. A relatively high share of domestic consumption in many Asian developing countries will
support the growth prospect. Stable inflows of remittances can also improve the balance of payment
through lowering the deficit in the current account, reduce the external debt burden and minimise
the savings–investment gap of the economy. The extent of the impact of remittances is indicated to
be larger than FDI and official development assistance (ODA) due to more stable inflows (Ratha,
2003). This might be the case in the long run, considering the fluctuation of FDI inflows within the
business cycle dynamics in the domestic and global economy.
According to the World Bank, global remittance flows have reached US$ 601 billion, which was
around 0.76 per cent of the GDP in 2015. Developing economies received around 73 per cent of global
remittances, which on average was about 25 per cent of the national income. Around 232 million inter-
national and seventy million internal migrants contributed to the remittances flows. Remittances
became the second largest source of external finance to developing economies behind FDI and that
recorded inflow is on average about twice as large as the official aids and nearly two-thirds of inward
FDI flows to developing economies in 2015. The enormous increase in remittances may be attributed to
the rise in immigration between developing and developed countries and a tremendous decline in the
expenditure for the transaction through technological improvement (World Bank, 2016).
This research is motivated by the latest phenomenon of worsening current accounts in Asian devel-
oping countries. The competition for FDI inflows in developing Asia as a source of growth and

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 3

domestic liquidity has been mounted since the Fed’s balance sheet normalisation started in late 2017.
With a large amount of capital returning back to the US economy, tighten global liquidity is expected.
Global growth also has a grim prospect particularly in developing and emerging economies, which
will limit FDI inflows. Consistent with the grim prospect of growth, capital outflows and current
account deficit can potentially become worse, which will put more pressure on the exchange rate.
Various economic reform policies that have been pushed forward may not necessarily have an imme-
diate impact in the short-term particularly related to the industrial transformation that requires sig-
nificant capital investments.
Despite numerous cross-country studies that focus on the impact of FDI and remittance inflows on
GDP and foreign exchange rates, the general consensus on the findings is still inconclusive. The fairly
ambiguous impact of capital inflows particularly FDI on recipient countries’ economy is due to among
others, differences in the domestic economic structures, human capital endowments, technological
advancements and capabilities. In addition, the majority of those studies analysed the impact of FDI
and remittances independently, thus, the results are not symmetrically fit for comparison. This study
aims to determine the impact of FDI and remittances simultaneously in developing Asia as the major
recipient of these capital inflows. The identification of long-run sensitivity of FDI and remittances to
GDP and the real exchange rate will enable Asian developing countries to further strategise and pri-
oritise their policy responses in the midst of global liquidity tightening and potentially worsening cur-
rent account deficit.
The remainder of the paper is outlined as follows. The next section documents a brief review of
related literature followed by the description of the Asian scenario of inflows of FDI and remittances
during the current age. Before continuing with a discussion on the empirical results, the data sources
and methodological issues are well documented. The final section summarises and concludes the
paper.

2. Literature Survey
In the Solow-type of standard neoclassical growth models, FDI is considered as an addition to the cap-
ital stock of the recipient countries. Based on this view, there is no significant difference between
domestic and foreign capital in terms of achieving a higher trajectory of economic growth. The impact
of FDI can be insignificant if we assume the perfect substitution between foreign and domestic capital.
However, empirical evidence on this theoretical fact is ambiguous (Hanson, 2001). Considering the
complementarity between foreign and domestic capital, the final impact of FDI on aggregate output is
believed to be greater as an outcome of these externalities.
De Mello (1999) argues that FDI plays a pivotal role in capital accumulation and intensification in
the total factor productivity. As a result, there is a possibility of a long term or more permanent
growth impact from FDI. However, due to the law of diminishing returns to capital, the short-run
growth impact of capital investment tends to be stronger than that of its long-run impact. The more
recently developed growth theories have assumed that knowledge and technology are factors of pro-
duction, and therefore these theories reject the theory of diminishing returns to capital (Grossman &
Helpman, 1991; Romer, 1994). This is aligned with the claim over rising productivity in the factors of
production due to knowledge base development (Hermes & Lensink, 2003).
Foreign direct investment inflows also augment the diversity of the intermediate products and
types of capital equipment in the economies of the recipient countries (Borensztein et al., 1998). Dif-
fusion of knowledge about the methods of production, product design and new organisational and
managerial techniques is the way in which FDI affects economic growth. Consequently, FDI will
improve the intensity and productivity of Research and Development (R&D) activities that expand
product diversification.
A number of empirical studies provide evidence of the positive impact of FDI on economic growth.
Koko (2006) determined that FDI inflows to developed economies enable the recipient countries to
adopt new technologies. Cross-country studies on the impact of FDI in developing economies also
reveal that FDI inflows support economic growth (Borensztein et al., 1998; Johnson, 2006). Using
panel data of 69 developing countries from 1970 to 1989, Borensztein et al. determine that FDI

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4 ECONOMIC PAPERS

supports economic growth if there is sufficient human capital in the host economy to absorb
advanced technologies. Johnson (2006) also finds that FDI inflows enhance economic growth in
developing economies, particularly in Asia during the period of observation from 1980 to 2002.
Hence, the study does not identify the significance of human capital in the form of years of schooling
as suggested by Borensztein et al. More recent literature on the nature of the relationship between
FDI and economic growth incorporates trade as the key factor of FDI in developing economies. In the
case of Asian countries, there is empirical evidence of a positive relationship between FDI and GDP
(Tiwari & Mutascu, 2011; Bhatt, 2014; Tan & Tang, 2016).
On the other hand, De Mello (1999) finds a weak relationship between FDI and GDP in 32 devel-
oped and developing economies during the period from 1970 to 1980. A recent study by Ali and Min-
gque (2018) also finds that there is no evidence of causality from FDI to GDP and vice-versa, while in
the long run, the positive impact of FDI on economic growth is insignificant. This study focuses on
four Asian developing economies (Indonesia, India, Malaysia and Bangladesh) for the years from
1990 to 2014. Other studies find a partial interrelationship between FDI and GDP, among others is
the study by Alfaro et al. (2004) that shows FDI inflows have a negative impact on the primary sector
but have a positive impact on the manufacturing sector.
A lesser degree of ambiguous results indicates the impact of remittance inflows on economic
growth. World Bank (2008) argues that remittances boost economic growth through direct linkage to
savings and investment as well as physical capital and indirect impact on consumption. Using panel
data for thirty-nine developing countries over the period of 1980–2004, Pradhan et al. (2008) confirm
the positive impact of remittances on GDP. A cross-country empirical study with over more than 100
countries between 1975 and 2002 also finds that remittance inflows promote economic growth in less
developed economies (Giuliano & Ruiz-Arranz, 2009). Remittances also benefit in reducing con-
sumption instability in those countries. In the case of Asian countries, Vargas-Silva et al. (2009) pro-
vide evidence on the positive impact of remittances on economic growth in twenty countries in the
region from 1988 to 2007.
Beck et al. (2007) confirm that remittance inflows positively impact the financial development that
leads to economic growth. Aggarwal et al. (2011) also evaluate the effect of remittances on develop-
ment in the financial sector by using data from 109 countries over the period of 1975–2007. Their
findings imply that inflows of remittances are positively associated with financial development. Fur-
thermore, Barajas et al. (2009) describe that remittances are liable to expand the quantity of the flows
of funds in the banking system, which will strengthen the financial sector development. The remitted
money by the migrant workers becomes one of the vital sources of financial capital (Fajnzylber &
Lop
ez, 2008). Since remittances reduce the financial constraints in the recipient countries, invest-
ments will also rise (Pradhan et al., 2008). This finding supports the transmission of impact from
remittance inflows to economic growth.
Despite numerous studies that find the significant impact of remittances, Rao and Hassan (2009)
find that remittance inflows have a positive but marginal influence on economic growth. Chami et al.
(2005) offer an explanation of why the impact of remittance inflows on economic growth is subopti-
mal. This is typically the case when remittances are not transformed into capital formation, that is,
remittances are not added to the stock of capital. In addition, Lipton (1980) argues that remittance
inflows can destabilise productivity and economic growth in less developed countries as they experi-
ence a rapid increase in consumption expenditure. Combes and Ebeke (2011) demonstrate that
remittance inflows reduce consumption instability at a significant level and this impact is stronger in
less developed nations. Remittances are relatively less volatile than other inflows of foreign curren-
cies, which enable the recipient country to maintain macroeconomic stability.
Numerous studies have examined the impact of capital inflows on real exchange rates. Combes
et al (2011) find that the composition of capital inflows and the type of exchange rate regime does
matter in determining the impact on the real exchange rate. Portfolio investment has the highest
appreciation effect among private inflows and its effect is much larger than FDI in a sample of forty-
two developing countries. However, remittances as part of private transfers have the least apprecia-
tion effect. Furthermore, the study also shows that a flexible exchange rate regime will more likely

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 5

dampen the impact of capital inflows on real exchange rate appreciation. Another study by Lartey
(2007) determines that capital inflow in the form of FDI and official aid also causes real exchange rate
appreciation in a group of Sub-Saharan African countries.
Capital inflows influence the exchange rate of a country through several channels. Generally, they
affect the foreign assets stock and the liabilities of the recipient country, which may lead to changes
in the real exchange rate. Another possible effect of capital inflows on exchange rates is through the
impact on growth (Acosta et al., 2009), although the impact depends on whether the inflows can be
channelled to productive economic activities. Inflows of capital will induce higher demand in the
tradable and non-tradable sectors, which lead to a higher relative price of non-tradable and to real
exchange rate appreciation. Amuedo-Dorantes and Pozo (2004) and L
opez et al. (2007) suggest that
appreciation of real exchange rates from remittances like other types of capital flows will switch
resource allocation from tradable to non-tradable sectors. While Acosta et al. (2009) and Lartey et al.
(2012) find that countries with a large amount of remittance inflows can expect lower economic
growth due to a real appreciation of exchange rate that potentially lower export competitiveness.
In general, an economy achieves external equilibrium when current account imbalances are com-
pensated by the stable inflows of foreign capital (Mussa, 1984). From the literature survey, there is a
strong indication that FDI and remittance inflows support economic growth and current account bal-
ance despite some outliers due to the economic fundamentals within a country or group of countries.
Furthermore, the impact of FDI and remittance inflows also differs depending on the continuity of
inflows. FDI tends to have more conditionality to be optimal in supporting growth and the current
account balance. FDI will raise the external liabilities leading to a decline in the net foreign asset posi-
tion of the recipient countries. While the fact those remittance inflows induce currency appreciation
depends on trade dynamics. Increases in export prices and decreases in import prices due to an appre-
ciation of the exchange rate may eventually outpace the depreciation of a currency through larger
deficits in the current account balance.

3. FDI and Remittance Inflows in Asian Economy

The declining trend of FDI in developing Asia is observed between two major economic downturns as
reflected in the GDP figures (Figure 1). First is the period of the economic downturn during the GFC
2008–2009, which resulted in a sharp decline of FDI from double-digit growth in 2006 and 2007 to
around 5.5 per cent in 2008. Strong commodity prices supported the rebound of FDI growth in 2009
that lasted until the peak of the commodity boom in 2011. The end of the commodity super-cycle
started to hamper FDI growth in 2012 and it continued to do so until 2015. Hence, the impact of FDI
on economic growth from 2006 to 2015 is evident. Correlation between FDI and GDP growth in the
nominal term during that period is at 0.86.
Despite the declining trend, developing Asia remains the biggest recipient of FDI. Inflows of FDI to
developing Asia contrast with the modest trends in other developing economies. However, among
developing Asian nations itself there are variations in FDI inflows particularly between 2013 and
2015. Compared to the previous years, a sizeable increase in FDI inflows went to developing coun-
tries in East and North-East Asia in 2015. A significant increase in FDI in those regions was recorded
in Hong Kong and China. The nominal FDI growth rate in China was much higher than in average
developing Asia in 2009–2011 (Figure 2).
With a modest increase of 6 per cent as compared to 2014, inflows of FDI to China reached US$
136 billion in 2015 an amount that is more than 24 per cent of the region. The decelerating trend in
FDI in China has been parallel with the economic growth trend of the country. FDI inflows to South-
east Asian nations are found to be almost stagnant in 2015. However, a declining trend by the rate of
29 per cent in 2015 is observed in Indonesia. South and South-West Asian countries experience a
remarkable boost in FDI inflows mainly due to a big amount of flows to India. With a 28 per cent
increase over the past year, India has accounted for US$ 44 billion inflows of FDI in 2015, due to its
certain progress in investment regulation and atmosphere. On the contrary, a continuous declining
trend in FDI inflows is found in North and Central Asian economies.

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30 % yoy CMA Avg Nom GDP Growth

25 Avg Nom FDI Growth

20 CORR Nom gFDI - gGDP: 0.86

15
10
5
0
–5
–10 GFC Commodity Bust
2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
Figure 1. Trend of FDI and GDP in Developing Asia
Source: World Bank (2017)

% yoy CMA Avg Nom gFDI Developing Asia

40
Nom gFDI PRC
30

20

10

–10

–20
2008
2006

2007

2009

2010

2011

2012

2013

2014

2015

Figure 2. Growth of FDI in Developing Asia and China

Source: World Bank (2017)

Fundamentally, the ratio of FDI over GDP also shows a declining trend over the period of 2006–
2015 (Figure 3). Between 2006 and 2007, the average ratio of FDI over GDP reached almost 3.7. The
GFC has caused the ratio of FDI over GDP to fall to 2.4 in 2009 before rebounded within a year,
although it never returned to the previous level before the GFC took place. By the end of 2015, the
ratio of FDI over GDP recorded its lowest level (2.3) during the 10-year period of observation from
2006 to 2015. Among developing Asia, the ratio of FDI over GDP in East Asia countries excluding
Southeast Asian countries (ASEAN) was the highest from 2005 to 2015 (Table 1). While developing
Southeast Asia and South Asia countries has an average FDI ratio over GDP of around 4 per cent for
the same observation period.
Inflows of remittances also have been the vital sources of capital resources transferred from over-
seas nations to developing countries particularly in the Asian region. There exists a positive associa-
tion between remittances and other capital inflows in those economies; however, inflows of
remittances are found to be less volatile than other types of capital inflows (Buch et al., 2002). The
plot of the FDI over GDP ratio from 2006 to 2015 indicates a higher fluctuation compared to the ratio

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 7

Ratio of Nom FDI over GDP

4.0 Ratio of Nom Remittances (rhs) 1.8

3.5 1.6

1.4
3.0
1.2
2.5
1.0
2.0
0.8
1.5 0.6

1.0 0.4

2008

2015
2005

2006

2007

2009

2010

2011

2012

2013

2014
Figure 3. Ratio of FDI and Remittances over GDP in Developing Asia
Source: World Bank (2017)

Table 1. Ratio of FDI and Remittance Inflows to GDP in Asia

Region/year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Ratio FDI over GDP

East Asia excl ASEAN 5.99 5.85 6.60 9.38 8.08 13.76 23.81 18.79 9.70 2.66 1.50
Southeast Asia 2.97 3.73 5.16 4.14 3.61 4.47 4.12 4.15 4.48 4.33 5.25
South Asia 6.94 5.44 4.95 4.39 3.66 3.43 4.58 3.37 3.08 3.13 2.88
Ratio remittances over GDP
East Asia excl ASEAN 3.58 2.35 2.20 2.10 2.27 1.96 1.31 1.42 1.11 1.19 1.31
Southeast Asia 3.21 3.10 3.06 2.81 2.85 2.84 2.75 2.64 2.93 2.82 2.96
South Asia 8.17 8.18 8.41 8.93 9.47 9.23 9.43 10.29 10.77 10.64 10.24
Source: Own calculation of authors using World Bank database.

of remittances over GDP. A large divergence between the ratio of FDI and remittances over GDP is
particularly observed in 2014–2015 with an increasing trend of remittances ratio that helped EA
economies overcome the slowdown in economic growth. On the contrary from the FDI ratio trend,
the highest ratio of remittances over GDP is in developing South Asia countries, followed by develop-
ing Southeast Asia countries. The ratio of remittances over GDP in developing East Asia countries is
slightly below 2 per cent on average between 2005 and 2015.
Following the GFC, the growth trend of remittances has also been declining. A sharp decline of
remittance growth is recorded from 2008 to 2010 (Figure 4) as a result of the significant downturn in
advanced economies as the recipient of foreign workers from developing Asia. Although remittances
only grew a single digit between 2013 and 2015, the growth trend was able to rebound in 2015 after
recording the slowest growth rate of 8.2 per cent in 2014. This development was also affected by the
recovery in advanced economies particularly the United States, which is the main destination for for-
eign workers from developing Asia. According to the United States Census Bureau, approximately 14
per cent of total migration was from Asian countries, in which a majority was from developing Asia.
The largest number of migration to the United States from developing Asia was recorded to be from
China and the Philippines.
Current trends show that the Asian migration is not only limited to advanced economies. The
intra-Asian migration has also occupied a remarkable place in the recent past (Asian Development
Bank (ADB), 2008). For instance, around 70 per cent of foreign workers are from other Southeast

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30 % yoy CMA Avg Nom GDP Growth

GFC Avg Nom Remittances Growth
25
CORR Nom gRemittances - gGDP: 0.88
20 Commodity Bust

15

10

0
2006

2007

2008

2009

2010

2011

2012

2013

2014

2015
Figure 4. Trend of Remittances and GDP in Developing Asia
Source: World Bank (2017)

Asian countries with remarkable representations of immigrants from the Philippines, Indonesia and
Thailand (Orozco & Fedewa, 2005).
Statistics on remittances sent by the expatriates to their home countries reveal that total remit-
tances to Asian countries occupy the major share of remittances around the globe (International
Fund for Agricultural Development (IFAD), 2009). For a few relatively smaller countries such as
Nepal and Tajikistan, remittances comprise of a non-trivial portion of their national income. It can be
observed from statistics that half of the top 10 remittance receiving countries across the world are
India, China, Philippines, Bangladesh and Vietnam. In aggregate, total remittances to these counties
have reached up to US$ 100 million in 2008. Developing Asia has occupied the highest recipients of
international remittances among all developing countries, with South Asia as the second largest
recipient in 2008. This has a significant impact on the domestic economy as shown by the significant
correlation between nominal remittances and GDP growth in all developing Asia (0.88).
There are two parts of the literature focusing on the impact of remittances on short-term fluctua-
tions, concentrating on the impact of remittances on economic growth in the long run. If the remit-
tances are countercyclical to the home economy, receiving countries could potentially use
remittances as part of their strategy to offset negative cyclical fluctuations in output. Sayan (2006)
found that remittance inflows are countercyclical and synchronous with the business cycle in Bangla-
desh, whereas in India inflows of remittances are also countercyclical but with a one-year lag
between remittances and aggregate income.
The possible reasons behind the response of remittances flow to cyclical fluctuations depend on the
motives of remitting during the fluctuations. If the migrated workers are concerned about the well-
being of their family members, and if during negative cyclical fluctuations an important share of
households’ incomes in their home country declines, then remitters may respond with an increase in
transfers. However, remittances may decline following negative cyclical fluctuations in output if
remitters are thinking to invest in their home countries. Even though these are appropriate explana-
tions for the cyclical behaviour of remittances, it is significant to state that it is not possible to explain
the motives for remitting just by observing the business cycle behaviour of remittances by observing
the movements of remittances.

4. Data and Methodology

4.1. Data Sources

For this empirical study, we collect the annual data on inflows of FDI (FDI), remittances (REMIT),
foreign exchange rate measured by the real effective exchange rate (REER) and gross domestic

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 9

product (GDP) from the World Development Indicators (WDI) published by World Bank over the
1981–2015 period. The selected countries in developing Asia include Afghanistan, Bangladesh, Bhu-
tan, Cambodia, China, India, Indonesia, Lao PDR, Malaysia, Maldives, Mongolia, Myanmar, Nepal,
Pakistan, Philippines, Sri Lanka, Thailand and Vietnam. The classification of developing countries is
based on income levels as categorised by the World Bank.
Based on the most recent empirical evidences, this study incorporates various macroeconomic fac-
tors influencing exchange rates and economic growth in developing nations, such as volume of trade
(TRADE) measured by the sum of total exports and imports, gross domestic capital formation (GDFC),
financial development (FIND) measured by the domestic credit to private sector, inflation (INFL)
measured by the GDP deflator, population growth (POPG) and governance (GOVN) measured by the
indicator of political stability and absence of violence or terrorism. The WDI provides the country-
wise data on all of these variables from 1981 to 2015 except the data on GOVN, which is collected
from the Worldwide Governance Indicators (WGI) published by the World Bank (2018) over the
same time period for all selected countries in Asia.

4.2. Theoretical Framework and Hypotheses

The standard theories on international trade and open economy macroeconomics with capital flows
would build-up a theoretical framework of the study. The economic output and foreign exchange
rate are the determined factors, whereas FDI and remittance inflows have been the focussed indepen-
dent variables in this paper. The empirical analyses also incorporate a few control variables such as
the volume of trade, gross domestic capital formation, financial development, inflation, population
growth and governance because of their possible function. Theoretical descriptions of the variables
based on the latest related available literature are presented as follows:

4.2.1. Foreign Direct Investment (FDI)

Foreign direct investment is one of the foremost indicators of globalisation nowadays and several
studies show that inflow of FDI has a considerable macroeconomic impact on GDP and the exchange
rate. We predict that FDI inflow positively impacts economic output and exchange rate of a country
as it brings foreign capital and enhances the foreign exchange reserve (Balasubramanyam et al., 1996;
Kotrajaras, 2010; Anwar & Cooray, 2015).

4.2.2. Remittance (REMIT)

Inflow of remittances from abroad is also an important factor particularly in developing Asia. Through
positive influences on consumption, savings and investments, and by providing a catalyst for finan-
cial markets, remittances are expected to have a positive contribution to the economy (Rahman,
2009; Azam & Hassan, 2013).

4.2.3. Foreign Exchange Rate (REER)

The real effective exchange rate, as a standard measure of foreign exchange rates, is significantly
influenced by both FDI and remittance inflows in a positive manner (Corden, 1994; Lartey et al.,
2012).

4.2.4. Gross Domestic Product (GDP)

The real GDP of the country, as the key dependent variable of this empirical exercise, is expected to
have significant effects from FDI, REMIT and other possible macroeconomic variables (Balasubra-
manyam et al., 1996; Andraz & Rodrigues, 2010; Anwar & Cooray, 2015).

4.2.5. Volume of Trade (TRADE)

Trade volume is a vital macroeconomic determinant of GDP and exchange rate. Several studies use
trade openness in this regard. Theoretically and empirically TRADE is expected to have a positive
impact on GDP and foreign exchange rates, depending upon the degree of imports (Benmamoun &
Lehnert, 2013).

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4.2.6. Gross Domestic Capital Formation (GDFC)

GDFC or Gross Fixed Capital Formation (World Bank), as a proxy for the domestic investment of an
economy, is predicted to have a highly positive effect on GDP (Solomon, 2011; Driffield & Jones,
2013).

4.2.7. Financial Development (FIND)

Through stimulating domestic investment and promoting the monetary system, the financial devel-
opment of a country should promote economic output (De Gregorio & Guidotti, 1995).

4.2.8. Inflation (INFL)

Inflation, measured by the GDP deflator of the country, is assumed to have a negative impact on GDP
(Borensztein et al., 1998; Driffield & Jones, 2013).

4.2.9. Governance (GOVN)

As a measure of the quality of governance in a country, the study predicts that a high score in gover-
nance positively impacts the level of economic output (Borensztein et al., 1998; Benmamoun & Lehn-
ert, 2013).

4.2.10. Population Growth (POPG)

The annual growth in population (%) is expected to have a negative influence on GDP of a country
as it may reduce the per capita income impacting savings and then investments (Benmamoun &
Lehnert, 2013; Driffield & Jones, 2013).
The basic objective of this study is to empirically examine the macroeconomic impact of FDI and
remittance inflows in developing Asian countries. The methodology to perform the empirical analysis
on the impacts of FDI and remittances on economic growth and exchange rate is a simultaneous
dynamic panel model. Hence, we carry out the testing of null hypotheses of the study as follows:
• Inflows of FDI and remittances do not influence GDP and exchange rate, and
• Patterns on the impact of FDI and remittance in Asian economies are indifferent.

4.3. Econometrics Methodology

The generalised method of moments (GMM) estimation is utilised in a dynamic panel framework for
controlling the endogeneity. The panel data models are more efficient to control the heterogeneity at
the individual level with the availability of more information. We employ the panel unit root tests
developed by Levin et al. (2002) (LLC) and Im et al. (2003) (IPS) to check stochastic properties of vari-
ables. Augmented Dickey–Fuller (ADF) specification of panel unit root test is presented in Equation 1:
X
Pi
0
Dyit ¼ qyi;t1 þ gij Dyi;t1 þ Xit d þ eit ð1Þ
j¼1

Levin et al. (2002) test permits intercept with residual variances; dynamic trends and the order of
autocorrelation; however, it needs the auto-generated time series with common sample size and
autocorrelation coefficient (q). The lag order, varying across individuals, is selected on the basis of t-
statistics of gij by permitting the utmost lag. The estimate of q can be obtained after estimating the
regression of Dyit on Dyi,tj and Xit. The common q criterion is the main weakness of the Levin et al.
(2002) test. But the IPS test considers the different q for all cross-section units under the heteroge-
neous panel. Arellano and Bond (1991) prescribed GMM technique is the widely used estimate for
fixed effect dynamic panel models, where, we first eliminate the fixed effects using first differences in
the variables and then estimate the instrumental variables in the differenced equation. The validity of
the instruments can be checked using the Sargan (1958) test. The one-period lag dynamic panel
model is presented as follows in Equation 2:

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 11

yit ¼ ai þ ht þ byi;t1 þ xit0 g þ eit ð2Þ

where ai = fixed effect, ht = time dummy, xit represents (k  1) 9 1 exogenous variables’ vector and
eit ~ N (0, r2) denotes random disturbances. Usually, in this type of panel data structure, the fixed
effect model is more appropriate than the random effect model. In order to eliminate the unobserv-
able state-specific effects, Equation 2 is differenced, by transforming it as follows:
Dyit ¼ Dht þ bDyi;t1 þ Dxit0 g þ Deit ð3Þ
The lagged difference of the logarithm of the dependent variable is correlated with the difference in
error terms. To remove this kind of endogeneity in Equation 3, instrumental variables with lags as
suggested by moment conditions are to be used. The differenced components of endogenous explana-
tory variables should also be treated cautiously. The GMM estimation also involves the instrument
specification, weighting matrix choosing and estimator determination.
In this particular empirical investigation, to find the impact of FDI and remittance inflows on GDP
and foreign exchange rate on a comparative basis in developing Asia, Equation 4 and 5 are estimated
separately using the panel data as follows:
0 0
DGDPit ¼ b11 DGDPit1 þ b12 Dx1it þ b13 Dx21it þ De1it ð4Þ

0
DREERit ¼ b21 DREERit1 þ b22 Dx1it þ b23 D022it þ De2it ð5Þ
In Equations 4 and 5, x01it denotes a matrix of the components of FDI and REMIT; x021it is a compo-
nent matrix of some control variables including GDFC, TRADE, REER, FIND, INFL, GOVN and POPG;
and x022it also represents a component matrix of another set of control variables including TRADE,
GDP, GDFC, FIND, INFL, GOVN and POPG. All other symbols used in Equations 4 and 5 follow their
usual meanings. As the study mainly focuses on FDI and REMIT in order to look at their comparative
impacts on GDP and RRER, Equations 4 and 5 are to be estimated first without considering x021it and
x022it , and then all respective control variables would be incorporated sequentially for testing the
robustness of results obtained from dynamic panel GMM estimations of Equations 4 and 5.
Arellano and Bond (1991) specified that the GMM estimate in the dynamic panel model provides
consistent outcomes when the number of cross-section units is higher than the number of time series
observations. The present study performs empirical analyses on selected eighteen Asian developing
economies over the period of 1981–2015. The number of time series units is reduced from thirty-five
to seven by taking the five-year non-overlapping moving average of the entire data series. Here, the
approach of Alguacil et al. (2011) following the method of Blundell and Bond (1998) is referred. This
technique also enables us to mitigate short-term fluctuations.

5. Empirical Results
In order to fulfil the research objectives of this empirical study, first, we present the descriptive statis-
tics of variables for the selected eighteen Asian developing countries in Table 2 based on a panel over
the period of 1981–2015 using the data collected from WDI and WGI. The major variables including
FDI, REMIT, GDP, TRADE, GDFC and FIND are measured in US Dollars in millions at 2010 constant
prices. REER denotes the index of real effective exchange rates considering 100 as the base measure
in the year 2010. The percentage of the GDP deflator of the country is utilised to measure the level of
inflation (INFL). The data on the WGI estimated indicator of political stability and the absence of vio-
lence or terrorism are used as the standard measure of governance (GOVN).
From Table 2, we observe that the net FDI inflows to selected Asian developing countries experi-
ence the range of US$ 4.65 million as the minimum to US$ 291,000 million as the maximum with an
average of US$ 16,200 million and the standard deviation of US$ 4900 million. Furthermore, REMIT
has a range from US$ 0.83 million to US$ 70,400 million with US$ 8010 million and US$ 1950 mil-
lion as the mean and standard deviation respectively. The range of 95.67–210.39 is found in case of
REER which witnesses the mean of 119.47 and standard deviation of 20.01. With US$ 563,000 mil-
lion as the mean and US$ 165,000 million as a high standard deviation, the GDP experiences the

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Table 2. Descriptive Statistics

Variables Mean Median Maximum Minimum SD Obs.

FDI 16,200 1980 291,000 4.65 4900 630

REMIT 8010 2830 70,400 0.83 1950 630
REER 119.47 114.94 210.39 95.67 20.01 630
GDP 563,000 74,200 11,100,000 1160 165,000 630
TRADE 316,000 40,500 4,790,000 32.83 178,000 630
GDFC 233,000 26,800 5,020,000 409 67,000 630
FIND 579,000 25,700 16,900,000 201 222,000 630
INFL 7.41 6.23 39.18 5.99 5.91 630
GOVN 0.73 0.74 1.28 2.81 0.98 630
POPG 1.47 1.37 3.87 0.35 0.69 630
Source: Own estimation of authors using World Bank database.

widest range from US$ 1160 million as the minimum value to US$ 11,100,000 million as the maxi-
mum value. In addition to that, TRADE has the minimum and maximum rages of US$ 32.83 million
and US$ 4,790,000 million, respectively, and the mean and standard deviation of it are found to be
US$ 316,000 million and US$ 178,000 million respectively.
The range of GDFC is US$ 409 to US$ 502,000 with the mean and standard deviation of US$
233,000 million and US$ 67,000 million respectively. FIND faces a wide range of US$ 201 million to
US$ 16,900,000 million and the values of the mean and standard deviation are documented to be US
$ 579,000 million and US$ 222,000 million respectively. The inflation (INFL) level accounts are
5.99 and 39.18 as its minimum and maximum values of range, respectively, where the average and
standard deviation are 7.41 and 5.91 respectively. The GOVN indicator experiences the range of
2.81 to 1.28, with the mean and standard deviation of 0.73 and 0.98 respectively. Finally, we note
that POPG varies within the range of 0.35 and 3.87 as the minimum and maximum values respec-
tively and moreover, it has the mean of 1.74 and a standard deviation of 0.69. Additionally, it is
important to mention here that descriptive statistics of variables are calculated on the basis of actual
time series units with yearly data and that is why wide ranges with high standard deviations are
observed in the case of some variables. However, for econometric analysis, the time points are
reduced by taking the non-overlapping moving average technique due to a methodological obligation
as stated earlier, and it is observed that several problems related to statistical dispersion are mitigated.
In the dynamic panel framework, to estimate the impact of FDI and remittance inflows on
exchange rates and economic growth, panel unit root tests developed by Levin et al. (2002) and Im
et al. (2003) are performed. Panel unit root test statistics are calculated for all underlying panels for
selected developing Asia countries that are being observed. The lag lengths are selected by following
the minimum Akaike (1969) information criterion rule. Both individual effects and individual linear
trends are incorporated as exogenous variables in the estimated equations. Table 3 reports the results
of panel unit root tests of the variables. We fail to reject the null hypothesis that the series contain
unit roots at the level both in terms of LLC and IPS tests. However, the first differences in variables
become stationary in terms of both panel unit root tests statistics. No period specific effect is observed
by including time dummies for all five-year periods.
Table 4 presents estimated outcomes of dynamic panel equations focussing the exploration of the
impacts of FDI and REMIT on GDP including some control variables like GDFC, TRADE, REER, FIND,
INFL, GOVN and POPG. Model 1 indicates the basic regression equation followed by the sequential
additions of earlier mentioned control variables captured by Model 2 to Model 8 respectively. Finally,
Model 9 concludes this estimation process of robustness checking by including all key and control
variables together in a single regression equation. The first-differenced GMM estimator referred by
Arellano and Bond (1991) is utilised to control the unobserved heterogeneity involved in the esti-
mated relationships. The presence of lagged dependent variable as the exogenous regressor in

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IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA 13

Table 3. Estimated Results of Panel Unit Root Tests

Series Levin et al. (2002) Im et al. (2003)

Level First difference Level First difference

FDI 1.07 5.12* 1.05 5.31*

REMIT 1.13 5.03* 1.11 5.07*
REER 1.21 5.81* 1.02 5.92*
GDP 1.09 4.99* 1.14 5.58*
TRADE 1.83 6.01* 1.57 6.01*
GDFC 1.89 4.97* 1.43 5.94*
FIND 1.33 5.18* 0.97 4.96*
INFL 1.67 5.11* 1.12 5.03*
GOVN 1.01 4.82* 0.99 4.96*
POPG 1.16 5.09* 1.06 5.15*

Note: * denotes level of significance at 10%.

Source: Own estimations of authors using World Bank database.

estimated regression equations captures the dynamics of GDP across the panel. The Arellano–Bond
second-order autocorrelation (AR(2)) text confirms the correct specifications of the models. The
reported P-values of all corresponding statistic of Sargan (1958), Hansen (1982), and Wald tests vali-
date that instruments are not endogenous. It is also satisfactory that the number of instruments is les-
ser than the number of cross-section units (i.e. countries) in each model. Estimated results reveal that
GDP is positively and significantly influenced by FDI and REMIT at first-differenced forms. However,
the extent of the impact of FDI on GDP in the observed Asian developing countries is lesser than that
of REMIT in terms of both coefficient value and level of significance, and this finding is robust as
almost every specified model refers, as shown in Table 4. It is also observed that GDFC, TRADE and
FIND are significant factors having direct relationships with GDP. However, as expected, REER, INFL
and POPG have negative and significant impacts on GDP. GOVN is found to be an insignificant factor
causing GDP.
The fact that remittances have a more significant impact on economic growth highlights the cir-
cumstances over the source of growth in developing Asia, which is still primarily domestic consump-
tion. The average share of domestic consumption over GDP in developing Asia is about 63.8 per cent
in 2016.1 A stable and increasing flow of remittances over time boosts the countries’ domestic con-
sumption. On the other hand, FDI inflow in the majority of Asian developing countries particularly
in the low-income and lower middle income countries tends to be more unstable. This is due to the
various determinant factors of FDI from political stability, long-term growth prospects, availability of
resources and infrastructures.
The outcomes from the panel data GMM estimation with REER as the dependent variable are pre-
sented in Table 5. FDI and REMIT are the independent variables of interest in the dynamic panel
models. Model 1 includes the main regressors. Same control variables are incorporated like the earlier
case due to their possible impacts on REER as chronologically presented in Model 2 to 8. At the end,
Model 9 observes the decisive outcomes by incorporating all variables together in a single regression
equation. In the present case also, the Arellano and Bond (1991) specified first-differenced dynamic
panel GMM estimation technique is employed. Estimated coefficients along with corresponding prob-
abilities of all regression models (1–9) presented in Table 5 refer to the positive and significant impacts
of FDI, REMIT, TRADE and INFL on REER at their first-differenced forms, where the extent of

1
As per the data from the World Bank and OECD national accounts data except for Maldives. Data for Afghani-
stan and Myanmar is from the year 2009 and 2015 respectively.

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Table 4. GMM Estimations of Impacts of FDI and REMIT on GDP

Dependent variable: ΔGDP (it)

Method: Panel GMM

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Model 9

ΔGDP (it  1) 0.32*** (0.00) 0.26*** (0.00) 0.28*** (0.00) 0.21*** (0.00) 0.27*** (0.00) 0.25** (0.02) 0.23** (0.01) 0.20*** (0.00) 0.12*** (0.00)
ΔFDI (it) 0.11** (0.01) 0.08** (0.03) 0.09** (0.02) 0.07** (0.04) 0.10** (0.03) 0.09*** (0.00) 0.06* (0.05) 0.09** (0.02) 0.04** (0.03)
ΔREMIT (it) 0.17*** (0.00) 0.12** (0.01) 0.11*** (0.00) 0.13*** (0.00) 0.14*** (0.00) 0.10** (0.01) 0.09** (0.02) 0.10*** (0.00) 0.08*** (0.00)
ΔGDCF (it) 0.16*** (0.00) 0.10*** (0.00)
ΔTRADE (it) 0.13*** (0.00) 0.09** (0.01)
ΔREER (it) 0.08** (0.02) 0.02** (0.02)
ΔFIND (it) 0.07*** (0.03) 0.01** (0.02)
ΔINFL (it) 0.04** (0.01) 0.01** (0.02)
ΔGOVN (it) 0.06 (0.23) 0.01 (0.21)
ECONOMIC PAPERS

ΔPOPG (it) 0.09** (0.02) 0.01** (0.02)

Observations 126 126 126 126 126 126 126 126 126
No. of Instruments 11 12 12 11 13 11 9 12 14
Arellano–Bond 0.39 0.42 0.35 0.51 0.45 0.48 0.36 0.53 0.59
Test for AR(2)
Sargan test, P-value 0.18 0.26 0.24 0.37 0.33 0.39 0.23 0.38 0.51
Hansen test, P-value 0.21 0.29 0.32 0.39 0.41 0.37 0.28 0.41 0.53
Wald test, P-value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Note: *, ** and *** denote level of significance at 10%, 5% and 1% level respectively. The P-values are in parentheses.
Source: Own estimation of authors using World Bank database.

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Table 5. GMM Estimation of Impacts of FDI and REMIT on REER

Dependent variable: ΔREER (it)

Method: Panel GMM

Variables Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Model 9

ΔREER (it  1) 0.29*** (0.00) 0.21*** (0.00) 0.23*** (0.00) 0.26*** (0.00) 0.19*** (0.00) 0.17** (0.02) 0.31*** (0.00) 0.16** (0.01) 0.11*** (0.00)

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ΔFDI (it) 0.09*** (0.00) 0.05** (0.02) 0.06** (0.02) 0.08** (0.03) 0.10** (0.01) 0.07** (0.03) 0.05** (0.02) 0.06** (0.02) 0.05** (0.02)
ΔREMIT (it) 0.13*** (0.00) 0.06*** (0.00) 0.08** (0.01) 0.09*** (0.00) 0.12** (0.01) 0.09*** (0.00) 0.08*** (0.00) 0.11*** (0.00) 0.09*** (0.00)
ΔTRADE (it) 0.11*** (0.00) 0.10*** (0.00)
ΔGDP (it) 0.07** (0.01) 0.03* (0.06)
ΔGDFC (it) 0.11 (0.19) 0.04 (0.17)
ΔFIND (it) 0.01* (0.07) 0.02 (0.20)
ΔINFL (it) 0.04** (0.01) 0.02** (0.02)
ΔGOVN (it) 0.17 (0.32) 0.03 (0.21)
ΔPOPG (it) 0.05** (0.01) 0.01** (0.03)
Observations 126 126 126 126 126 126 126 126 126
No. of instruments 9 11 11 12 11 10 8 10 14
Arellano–Bond test 0.41 0.43 0.39 0.47 0.34 0.37 0.31 0.42 0.51
for AR(2)
Sargan test, P-value 0.23 0.27 0.21 0.35 0.39 0.35 0.22 0.40 0.49
Hansen test, P-value 0.31 0.33 0.32 0.36 0.34 0.39 0.29 0.41 0.52
Wald test, P-value 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
IMPACTS OF FDI AND REMITTANCE INFLOWS IN DEVELOPING ASIA

Note: *, ** and *** denote level of significance at 10%, 5% and 1% level respectively. The P-values are in parentheses.
Source: Own estimation of authors using World Bank database.
15
16 ECONOMIC PAPERS

influence of REMIT on REER is found to be higher than that of FDI. However, REER is negatively
influenced by GDP and POPG in the observed Asian developing countries as results indicate. Similar
to the previous one, here also the Arellano–Bond AR(2) test, number of instruments along with sev-
eral endogeneity tests including Sargan (1958), Hansen (1982) etc. ensure that all models are cor-
rectly specified, and finally it can be concluded that the main outcome is robust as it is found to be
consistent across all specified models.
This phenomenon indicates that higher growth tends to accelerate aggregate demand in developing
Asia. This potentially creates an overheated economy, which drives higher inflation and eventually
lowers REER. The impact of remittance inflows on exchange rates as well as economic growth is sig-
nificantly higher than that of inflows of FDI in the observed Asian developing countries. This result
confirms the importance of stability of inflows to the developing economies in supporting the
exchange rate levels by an adequate supply of foreign currency. Certain types of FDI also require a
significant import of capital goods in the form of machinery and equipment, which will also limit the
amount of actual inflows to the country’s economy.

6. Conclusion
The paper empirically investigates the dynamic impacts of FDI and remittance inflows on the
exchange rate and economic growth in Asian developing economies using the data collected over
the period of 1981–2015 and employing the technique of GMM estimate as referred to by Arellano
and Bond for a dynamic panel structure. The empirical findings highlight that the real effective
exchange rate and economic growth are positively influenced by both types of inflows namely FDI
and remittances in Asian developing countries, but the degree of impact of remittances are found to
be greater than FDI inflows . These findings support the hypothesis that remittance inflows are rela-
tively more stable as widely documented in other studies.
The existing literature advocates that the host economy should accomplish certain pre-requisites
including the sociopolitical and macroeconomic stability, good governance, financial development,
skill formation and adequate infrastructure to have optimal impacts of FDI on economic growth
(Alguacil et al, 2011). Developing economies in Asia should also concentrate on tax incentives and
trade openness in order to best optimise the impacts of capital inflows on the domestic economy.
Attracting FDI with export orientation should also be a strategy and instead of competing for FDI
from advanced economies, developing economies can collaborate to build regional investment initia-
tives. Policies that focus on improving the inflow of remittances should also become a priority. An
efficient system of financial intermediaries will reduce the cost of sending remittances to the recipient
countries. Incentives structures should also be provided to channel the remittances into productive
investments in a domestic economy.

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