An empirical investigation of foreign direct investment and economic growth in SAARC nations

Purpose – This paper aims to investigate the causal nexus between foreign direct investment (FDI) and economic growth in SAARC countries. Design/methodology/approach – Johansen's cointegration test was employed to examine the long‐run relationship between foreign direct investment and economic growth in SAARC countries. Besides, the vector error correction model (VECM) was employed to examine the causal nexus between foreign direct investment and economic growth in SAARC countries for the years 1970‐2007. Finally, the impulse response function (IRF) has been employed to investigate the time paths of log of foreign direct investment (LFDI) in response to one‐unit shock to the log of gross domestic product (LGDP) and vice versa. Findings – The Johansen cointegration result establishes a long‐run relationship between foreign direct investment and gross domestic product (GDP) for the sample of SAARC nations, namely, Bangladesh, India, Maldives, Nepal, Pakistan and Sri Lanka. The empirical results of the vector error correction model exhibit a long‐run bidirectional causal link between GDP and FDI for the selected SAARC nations except India. The test results show that there is a one‐way long‐run causal link from GDP to FDI for India. Research limitations/implications – This paper employed annual data to examine the causal nexus between FDI and economic growth. Therefore, researchers are encouraged to test the FDI‐growth relationship further by using quarterly data. Practical implications – The SAARC nations should adopt effective policy measures that would substantially enlarge and diversify their economic base, improve local skills and build up a stock of human capital recourses capabilities, enhance economic stability and liberalise their market in order to attract as well as benefit from long‐term FDI inflows. Originality/value – This paper would be immensely helpful to the policy makers of SAARC countries to plan their FDI policies in a way that would enhance growth and development of their respective economies.