The topic of Foreign Capital Inflows (FCI) to Pakistan got much attention in empirical literature, but the existing literature on FCI about Pakistan mostly used the customary econometric tools like OLS, 2SLS, FIML and 3SLS for analysis. However, we know that most of the macroeconomic variables are non-stationary, which mandates the re-examination of the past studies using new time-series tools like cointegartion and ECM. Thus, the present book re-examines the macroeconomic role of Foreign Capital Inflows (FCI) in Pakistan through applying vector error correction model (VECM) on annual time-series data for the period of 1972-2006.
The present study does not find any evidence for direct positive impact of aggregate FCI on GDP growth and Investment (capital formation). However, the study finds the positive (complementary) relationship between FCI and domestic saving, thus suggesting an indirect positive impact of FCI on GDP through supplementing domestic resources. These results seem contradicting i.e. positive relation with domestic savings but negative linkages with investment and growth. However, we can interpret it as that FCI is supplementing the domestic resources and there is a need and justification for FCI in Pakistan due the shortage of domestic savings. But, these inflows of foreign capital are not transforming in the productive investment and thus not boosting economic growth. As this study shows that most of FCI are of non-investment (non FDI) type and are concentrated in the selected non-export-oriented and less-employment-generating sectors. In addition, the present study finds that exchange rate depreciation and current account deficit causes more inflows of foreign capital in Pakistan. While FCI also results in increasing the import of goods and services in Pakistan.
Subsequently, the present study suggests some policy recommendations like: (i) to target and identify the potential sectors for inviting the inflows of foreign capital, (ii) to change in composition of existing FCI, from non-FDI to FDI (investment) forms of FCI, (iii) to diversify the existing FCI from non-tradable and less job-oriented sectors to the tradable (export-oriented) and specially in agricultural-related manufacturing sectors, (iv) to mobilize the domestic resources, that will reduce the reliance on foreign assistance, and (v) to control the current account deficit and to stabilize the exchange rate, which will be helpful in reducing the reliance on foreign capital.
Table of Contents
Chapter 1. Introduction
1.1 Background and Statement of Problem
1.2 Research Question
1.3 Research Objectives
1.4 Significant Contributions of the Study
1.5 Organisation of the Book
Chapter 2. Review of Selected Literature
2.1 FCI and Economic Growth: A Review of Literature
2.2 FCI and Domestic Savings: A Review of Literature
2.3 FCI and Investment: A Review of Literature
2.4 FCI and Exchange Rate: A Review of Literature
2.5 Some Other Aspects of FCI: A Review of Literature
Chapter 3. Research Design
3.1 Foreign Capital Inflows: A Theoretical Framework
3.2 Hypotheses to be tested
3.3 Data Specifications
3.3.1 Types and Measurement of FCI
3.3.2 Variables Description
3.3.3 Sources of the Data and Sample Period
3.4 Model Specifications
3.4.1 FCI and GDP: Vector Error-Correction Model (3.1)
3.4.2 FCI and Investment: Vector Error-Correction Model (3.2)
3.4.3 FCI and Savings: Vector Error-Correction Model (3.3)
3.4.4 FCI and CAD: Vector Error-Correction Model (3.4)
3.4.5 FCI and Exchange Rate: Vector Error-Correction Model (3.5)
3.4.6 FCI and Imports: Vector Error-Correction Model (3.6)
3.5 Research Methodology
Chapter 4. FCI Statistics: Some Evidence from Pakistan
4.1 Trends, Composition and Sector-Wise Distribution of FCI in Pakistan
4.1.1 Foreign Capital Inflows to Pakistan: Trends 1972-2006
4.1.2 Composition of FCI in Pakistan (19976-2006)
4.1.3 Sector-wise Distribution of FCI in Pakistan
4.2 A Need-Based Analysis of FCI in Pakistan
4.2.1 Savings-Investment Gap in Pakistan
4.2.2 Export-Import Gap and FCI in Pakistan
4.2.3 Current Account Deficit and FCI in Pakistan
Chapter 5. Econometric Analysis
5.1 FCI and GDP: Econometric Analysis and Results
5.1.1 FCI and GDP: Unit Root Test& Order of Integration
5.1.2 FCI and GDP: VAR Lag-Order Selection
5.1.3 FCI and GDP: Johansen Cointegration Test Results
5.1.4 FCI and GDP: VECM Estimations and Results
5.1.5 FCI and GDP: Impulse Response Function
5.1.6 FCI and GDP: Results and Findings
5.2 FCI and Investment: Econometric Analysis and Results
5.2.1 FCI and Investment: Unit Root Test & Order of Integration
5.2.2 FCI and Investment: VAR Lag-Order Selection
5.2.3 FCI and Investment: Johansen Cointegration Test
5.2.4 FCI and Investment: VECM Estimation and Results
5.2.5 FCI and GCF: Impulse Response Function
5.2.6 FCI and GCF: Results and Findings
5.3 FCI and Savings: Econometric Analysis and Results
5.3.1 FCI and Savings: Unit Root Test & Order of Integration
5.3.2 FCI and Savings: VAR Lag-Order Selection
5.3.3 FCI and Savings: Johansen Cointegration Test
5.3.4 FCI and Savings: VECM Estimation and Results
5.3.5 FCI and GDS: Impulse Response Function
5.3.6 FCI and GDS: Results and Findings
5.4 FCI and Current Account Deficit: Econometric Analysis and Results
5.4.1 FCI and CAD: Unit Root Test & Order of Integration
5.4.2 FCI and CAD: VAR Lag-Order Selection
5.4.3 FCI and CAD: Johansen Cointegration Test
5.4.4 FCI and CAD: VECM Estimation and Results
5.4.5 FCI and CAD: Impulse Response Function
5.4.6 FCI and CAD: Results and Findings
5.5 FCI and Exchange Rate: Econometric Analysis and Results
5.5.1 FCI and Exchange Rate: Unit Root Test & Order of Integration
5.5.2 FCI and Exchange Rate: VAR Lag-Order Selection
5.5.3 FCI and Exchange Rate: Johansen Cointegration Test
5.5.4 FCI and Exchange Rate: VECM Estimation and Results
5.5.5 FCI and Exchange Rate: Impulse Response Function
5.5.6 FCI and Exchange Rate: Results and Findings
5.6 FCI and Imports: Econometric Analysis and Results
5.6.1 FCI and Imports: Unit Root Test & Order of Integration
5.6.2 FCI and Imports: VAR Lag-Order Selection
5.6.3 FCI and Imports: Johansen Cointegration Test
5.6.4 FCI and Imports: VECM Estimation and Results
5.6.5 FCI and IMP: Impulse Response Function
5.6.6 FCI and IMP: Results and Findings
Chapter 6. Conclusion and Policy Implications
6.1 Conclusion
6.2 Policy Recommendations
Research Goals and Topics
This work aims to analyze the macroeconomic effects of foreign capital inflows (FCI) on Pakistan's economy by examining the long-run causal relationships between FCI and key economic indicators such as GDP growth, domestic savings, investment, exchange rates, current account deficits, and imports, utilizing modern time-series econometric tools like the Vector Error Correction Model (VECM).
- Analysis of historical trends and sector-wise distribution of foreign capital in Pakistan.
- Evaluation of the causal linkages between FCI and national economic growth indicators.
- Application of advanced time-series techniques (Johansen cointegration and VECM) to improve upon traditional econometric methods.
- Identification of gaps in current capital utilization and recommendation of strategic policy adjustments.
Excerpt from the Book
1.1 Background and Statement of Problem
A man is poor because he is poor is an oft-quoted maxim which is also true in case of a poor country because mostly the poor countries (or underdeveloped countries) are entrapped in the ‘vicious circle of poverty’. They already lack the capital resources and at the same time the domestic saving ratios also remain low due to low income, resulting in low investment levels. Simultaneously, exports always remain lower than the imports in such countries. In such situations, the underdeveloped countries (UDCs) have to face saving-investment deficit as well as the deficit in balance of payments (BOP). The Two-Gap Model suggests that the developing countries have to rely on the foreign capital inflows (FCI) to fill these two gaps: the import-export gap and the saving-investment gap. Along with these government earnings of the UDCs governments, also remains lower because of low tax-paying capacity of poor people of the country. Thus these three deficits (saving deficit, fiscal deficit and BOP deficit) provide a sound rationale for the inflows of foreign capital in UDCs.
A large body of literature both empirical and theoretical suggests that Foreign Capital Inflows to poor countries are significant for a number of reasons. Foreign capital inflows, as discussed earlier, can finance required investment and stimulate economic growth. FCI may increase welfare by enabling households to smooth out their consumption over time and achieve higher levels of consumption. FCI helps in filling the saving-investment and export-import gaps. FCI also helps in structural transformation of economy through technology transfer. However, some other researchers found negative impacts of FCI, that is, large capital inflows can also have unfavourable macroeconomic effects, like rapid monetary expansion, higher inflationary pressures, and real exchange rate appreciation and widening current account deficits. FCI may also distort (substitute) the domestic savings. Hence, a surge in inflows of the foreign capital seen in recent years may create problems for economic policy, especially in the present environment of globalization and free capital mobility.
Summary of Chapters
Chapter 1. Introduction: Presents the background of the study, the research problem regarding capital deficits in developing countries, and defines the core objectives of the research.
Chapter 2. Review of Selected Literature: Provides an extensive overview of existing empirical studies concerning the relationship between foreign capital inflows and variables such as economic growth, savings, investment, and exchange rates.
Chapter 3. Research Design: Describes the methodology, theoretical framework, data specifications, and the specific Vector Error Correction Models (VECM) used to test the research hypotheses.
Chapter 4. FCI Statistics: Some Evidence from Pakistan: Analyzes the statistical trends, composition, and sector-wise distribution of foreign capital in Pakistan and evaluates the need for foreign inflows.
Chapter 5. Econometric Analysis: Presents the results of the econometric estimations, investigating the unit root, cointegration, and causal linkages between FCI and various macroeconomic indicators.
Chapter 6. Conclusion and Policy Implications: Summarizes the key findings of the study and offers policy recommendations for the effective management and diversification of foreign capital inflows in Pakistan.
Keywords
Foreign Capital Inflows, Pakistan, Vector Error Correction Model, VECM, Cointegration, Economic Growth, Domestic Savings, Investment, Current Account Deficit, Exchange Rate, Macroeconomic Analysis, Capital Accumulation, Two-Gap Model, Econometrics, Policy Implications
Frequently Asked Questions
What is the core focus of this research?
The research examines the macroeconomic role of Foreign Capital Inflows (FCI) in Pakistan, specifically investigating their long-term causal links to economic growth and other key indicators.
Which specific variables does the study analyze in relation to FCI?
The study analyzes GDP growth, domestic savings, capital formation (investment), current account deficits, official exchange rates, and imports.
What is the primary objective of this study?
The objective is to re-examine the relationship between FCI and Pakistan's macroeconomic development using modern time-series tools, providing a more accurate assessment than previous studies that relied on traditional methods like OLS.
What scientific methodology is utilized in this book?
The author uses the Johansen Cointegration technique and Vector Error Correction Models (VECM) to capture simultaneous effects and long-run causal relationships between non-stationary macroeconomic variables.
What main topics are covered in the book’s chapters?
The book covers the theoretical framework, a comprehensive review of literature, detailed descriptive statistics for Pakistan, and rigorous econometric analysis of the variables, concluding with policy recommendations.
What are the primary keywords associated with the findings?
The findings are centered around FDI, FCI volatility, bidirectional causality, cointegration, and the need for sector-specific diversification of foreign capital.
Did the study find a positive direct impact of FCI on GDP growth?
No, the study does not find evidence of a direct positive impact of aggregate FCI on GDP growth or capital formation, often citing high volatility and a concentration of inflows in non-productive sectors.
What is the recommended policy action regarding the composition of capital?
The author recommends shifting the composition of foreign inflows from non-FDI (such as aid or non-tradable loans) toward Foreign Direct Investment (FDI) directed into tradable and export-oriented sectors.
- Quote paper
- Ghulam Mohey-ud-din (Author), 2008, The Macroeconomic Analysis of Foreign Capital Inflows in Pakistan, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/169492
