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Caspian Journal of Applied Sciences Research, 2(3), pp.

117-127, 2013
Available online at http://www.cjasr.com
ISSN: 2251-9114, 2012 CJASR

Full Length Research Paper

Foreign Direct Investment (FDI) in Pakistan: Measuring Impact of Cost of War


Against Terrorism, Political Instability and Electricity Generation
Afza Talat 1, Anwar Zeshan 2
1
COMSATS Institute of Information Technology, Lahore
2
COMSATS Institute of Information Technology, Sahiwal
(PAKISTAN)
*Corresponding Author: Anwar Zeshan, zeshan@ciitsahiwal.edu.pk

Received 21 December 2012; Accepted 24 February 2013

Foreign Direct Investment (FDI) was proven to be a significant source of investment for developing countries
which helps to bridge saving-investment gap, creation of employment opportunities, transfer of technology, and
ultimately increasing economic growth of the host countries. This study empirically investigated the
determinants of FDI for Pakistan for the period 1980 to 2010 by using annual secondary time series data. The
study for the first time tested the impact of cost of war against terrorism, political instability, electricity
generation, (along with the control variables of market size, inflation rate, exchange rate stability, trade openness
and incentives provided to investors) on FDI inflows in Pakistan by using both ARMA model and ordinary least
square regression technique. As expected, the estimated results confirmed that the war against terrorism and
political instability had negative impact whereas electricity generation had a positive impact on FDI flows in
Pakistan. Among the control variables market size, exchange rate stability, trade openness and incentives
provided to investors had positively influenced the FDI whereas the inflation rate shown a negative relationship
with foreign direct investment flows.

Key words: Foreign direct investment, Pakistan, cost of war against terrorism, political instability, electricity
generation.

1. INTRODUCTION by different countries to attract and benefit from


this phenomenon. Developing countries face the
During the last couple of decades, much has been dilemma of saving-investment gap and thus foreign
written and discussed about the role and direct investment may be helpful in fostering
decisiveness of foreign direct investment in the economic growth by bridging this gap, transferring
context of its contribution to the growth of innovative and advanced technology and escalating
developing economies. FDI not only provides productivity, creation of employment and also
developing countries with the much needed capital increasing competition. FDI has proven to be a
for investment, it also enhances job creation, breath providing factor to third world countries to
managerial skills as well as transfer of technology. strengthen their national markets. Therefore, most
All of these ultimately contribute to the economic of the developing countries are very keen to attract
growth and development (Wafure and Nurudeen, more inflows of FDI.
2010). Developing countries are motivated enough FDI is very crucial for the economic growth of
to contest in attracting the foreign investment in Pakistan as well since its economy faces the
order to foster and regulate the industrial sector in dilemma of saving-investment gap. Pakistan does
their respective countries. Policies are being not have sufficient internally generated sources to
framed, amended, and regulated in order to make it maintain the tempo of economic activities,
convenient for foreign investors to make therefore, FDI is very important to complement the
investment in these countries. Fortunately or domestic investment in order to achieve economic
unfortunately, few nations benefited in attracting objectives. FDI is crucial for Pakistan in order to
foreign investment and few started suffering. This finance development projects, strengthening
situation leads to pondering on the issue of industrial sectors, increasing employment
investigating the reasons behind, while evaluating opportunities, attaining improved technology,
the nature of the strategies and policies formulated enhancing domestic managerial skills, enhancing

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Foreign Direct Investment (FDI) in Pakistan: Measuring Impact of Cost of War Against Terrorism, Political
Instability and Electricity Generation

productivity and output, improving balance of due to the volatile political conditions and
payments, improving foreign exchange reserves, therefore, are unwilling to undertake investment
improving physical infrastructure and human projects in Pakistan. Hence, it can be hypothesized
resources and ultimately achieving higher rate of that political instability in Pakistan is also
economic growth. adversely affecting FDI inflows.
Economy of Pakistan has been under severe Another major current challenge being faced by
economic pressure because of War against Pakistan is the electricity shortfall resulting in load
Terrorism, which is expanding for the last four shedding. Load shedding of electricity in Pakistan
years in Afghanistan. Since 2006, that War has has risen manifold and is severely affecting all
spread like contamination in Pakistani areas and it sectors of the economy including FDI inflows.
has cost us more than 35,000 people, 3,500 Although the Government assured that the load
security staff, infrastructural destruction, millions shedding will end by the end of 2009, whereas it
of citizens internal migration, deterioration of has been doubled in comparison to 2009.
investment environment, huge decline of Government has been unsuccessful in fulfilling
productivity, rising unemployment and especially their promises and therefore, investors are hesitant
decline of economic activity (Economic Survey, to make investment within Pakistan. It is one of the
2010-2011). Pakistans economy has not major issues in Pakistan and also expected to affect
experienced such a destructive economic and FDI inflows significantly as the domestic and
social turmoil ever before. Pakistan is continuously foreign investors are shutting down their industrial
paying serious price both in security and economic units since it is impossible to sustain without the
terms and a larger proportion of its resources is provision of electricity.
being utilized for this war since the year 2000. A remarkable growth for world FDI has been
Pakistans economy is bearing massive direct and witnessed during the last 20 to 25 years. Aggregate
indirect costs, which have risen from $ 2.669 FDI stock amounted to merely 6.6 % of world
billion during 2001-2002 to $ 13.6 billion during GDP in 1980, whereas, it has risen to nearly 23 %
2009-2010, and are expected to reach at $ 17.8 in 2003 (UNCTAD, 2004). World FDI inflows
billion during 2010-2011 (Economic Survey, 2010- during 2010 accomplished a projected amount of
2011). During the last 10 years, direct and indirect $1,244 billion (UNCTAD, 2010) representing a
costs of war against terrorism for Pakistan are $ smaller rise from 2009 position of $1,185 billion.
67.926 billion (Economic Survey, 2010-2011). The FDI growth within developing economies
Investments to GDP ratio of Pakistan has dropped grew from $ 2.4 billion annually in year 1962 to
from 22.5 % during 2006-2007 to 13.4 % during about $ 17 billion in year 1980. Flows of
2010-2011 and it also has severe affects on developing nations grew by 40% ($ 233 billion)
economys job creating capacity (Economic during 2004. Consequently, their portion of
Survey, 2010-2011). Current security conditions aggregate FDI stock was recorded at 36% which
are the crucial determinant of present and future is the highest percentage since year of 1997.
FDI flows. Based on facts and figures, it is Contrary to the developed region and transition
expected that cost of war against terrorism is economies where FDI flows declined during the
significantly influencing FDI inflows in Pakistan. year of 2010, FDI flows mounted by 12 % (i.e. $
Poon (2000) argued that MNCs select a location 574 billion) in developing countries during 2010.
that is politically stable for investment. Thus, Pakistan has received relatively greater FDI
stability of political environment in a country is a flows during the last two decades, because of its
major factor for MNCs while selecting their market oriented investment strategies and
investment destination. Since its independence in investment enabling environment. Because of the
1947, Pakistan is facing the problem of political restrained investment strategies, FDI flows were
instability which hinders inflows of FDI in meager upto 1991; though, it gradually went up
Pakistan. Akhtar (2000) has mentioned that during post liberalization era (Khan, 2000). FDI
political instability has been a common improved from $ 23 million during 1970 to $64
phenomenon in Pakistan and affecting almost all million during 1980 (UNCTAD, 2010). The
sectors of the economy and also deteriorating second spur took place during late 1980s, when
investors confidence on Pakistans investment government eliminated restrictions for flows of
environment. Domestic as well as foreign investors capital, ownerships and transfer of remittances.
are hesitant to make investments in Pakistan due to The time period after 1988 is associated with
its unstable political environment. Investors are privatization and liberalization processes which
uncertain about their future return on investment helped in accelerating FDI inflows from $ 110

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Caspian Journal of Applied Sciences Research, 2(3), pp. 117-127, 2013

million during 1987 to $ 711 million during 1997 balance and dummy variable for the Canadian
(Husain, 1999). These flows declined by $ 183 investment were significantly negative. Yang et al.
million during 2000. There is a major rise in (2000) analyzed the quarterly FDI inflows to
capital inflows since 2004 where FDI amounts ascertain the important determinants of Australian
reached to $ 5.4 billion during 2008, representing FDI. The change in the host countrys interest rate,
443 % increase in comparison to 2004; but, just changes in wage rates and industrial disputes
0.26 % greater than 2007. FDI flows had a enhanced FDI flows, whereas lagged inflation and
decreasing trend tendency after 2007. openness decreased these flows.
Consequently, during 2009 FDI amounted to $ Fuat and Ekrem (2002) investigated the
3.21 billion, presenting a 51.1% decrease as determinants of FDI inflows in Turkey for the
compared to 35.3% decrease in previous year. period of 1980-1998 by using Johansen co-
Overall, Pakistan has a lot of potential for integration technique. The study found that the
attracting FDI. Even though growth in FDI trend host countrys market size, infrastructure,
for several sectors reveals policies success; attractiveness of domestic economy and openness
however, FDI flows significantly slowed down of economy were positively related to inflows of
because of the worsening security conditions, FDI. The results had further shown that instability
institutions weaknesses, corruption, political of exchange rate negatively affect FDI, whereas
instability, weaker regulatory structures, and the variable representing instability of economy
unstable global political relationships. The present had negative but insignificant relationship with
study therefore, aims at exploring the relationship FDI inflows. Fedderke and Romm (2004) probed
of cost of war against terrorism, political FDI determinants within South Africa by utilizing
instability, electricity generation, market size, cointegration along with error correction
inflation rate, exchange rate stability, trade techniques. Their findings demonstrated that
openness and incentives provided to investors with political risk, property rights, market size, labor
inflows of FDI in Pakistan for the period of 1980 cost, openness and corporate tax rates were
to 2010 through Ordinary Least Squares (OLS) important variables in attracting FDI. Elijah (2006)
regression technique. examined the locational factors of FDI inflows in
The rest of the study has been organized as Kenya by applying Johansen co-integration, OLS
follows: section two presents literature review, and ECM techniques. The study found that
section three explains materials and methods openness of economy and human capital had
whereas results have been explained in section four positive effect on inflows of FDI in the shorter
and section five presents the discussions. time period. But real exchange rate and inflation
had negative relationship with FDI inflows in the
2. LITERATURE REVIEW long-run and short-run respectively. Moolman et.
al (2006) focused on the supply side determinants
A number of perspectives and theories have been of FDI in South Africa for the period 1970-2003.
established to explain the pattern and level of FDI The findings pointed that openness, size of market,
since the late 1950s. Both empirical and theoretical nominal exchange rates and infrastructure were the
research on the motivation for FDI and the variables which policy makers in South Africa
formation of multinational enterprises (MNEs) has should concentrate on while striving to attract FDI.
emphasized and pointed out different variable Sinha (2007) in his thesis focused on what the
effecting FDI flows. Given that there are numbers emerging economies (India) could learn from
of theoretical models which explain FDI flows, a leader economies (China) for inviting FDI flows.
number of variables have been tested in empirical He compared FDI inflows in India and China and
studies to ascertain their impact on FDI. found that India had developed because of its
For instance, Tcha (1999) explored the human capital, market size, political stability and
determining factors of Australian FDI flows market growth rate. Whereas, in case of China,
utilizing a combination of country-specific and congenial business climate variables consisting of
aggregate quarterly pooled data (six developed creating strategic infrastructure, making structural
economies including the US, the UK, Japan, New changes, undertaking strategic policy initiatives for
Zealand, Germany and Canada). In quarterly FDI providing economic freedom, creating flexible
model, labor disputes and real exchange rate were labor laws and opening up of its economy were
the only two determining variables. Whereas, in recognized as significant factors for attracting FDI.
country-specific model of FDI, volatility of Mottaleb (2007) identified influential variables of
exchange rate, home countrys current account FDI in 60 developing nations through OLS

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Talat et al.
Foreign Direct Investment (FDI) in Pakistan: Measuring Impact of Cost of War Against Terrorism, Political
Instability and Electricity Generation

methodology for period of 2003-2005. He resources, economys openness and governance


confirmed that more GDP, larger growth rate of system quality had significant positive association
GDP, friendly business environment and whereas individualism, hierarchal distance and
infrastructure effectively attracted FDI. Demirhan corruption control had negative association with
and Mascan (2008) explored determining variables FDI inflows.
of FDI inflows within 38 developing nations Researchers had also investigated various
through regression analysis covering period of factors which determine the level of FDI inflows in
2000-2004. Results revealed that per capita GDP Pakistan. For example, Akhtar (2000) analyzed
growth rate, telephone lines per 1,000 persons and locational determinants of FDI. The author argued
openness had significant and that market size, exchange rate and relative interest
positive relationship, while taxation rates and rate had positive and significant relationship with
inflation had significant but negative association FDI stock. Shah and Ahmad (2003) examined the
with FDI inflows. determinants of FDI for the period of 1961-2000
Masuku and Dlamini (2009) investigated by applying Johansen co-integration which was
locational variables of FDI in Switzerland by followed by Error Correction Model (ECM). The
utilizing Cointegration along with ECM techniques author found that cost of capital had negative
over period of 1980-2001. The authors concluded relationship, while infrastructure, tariffs, market
that internal and external economic stability, size and political stability had positive relationship
infrastructure and economys openness had with FDI inflows. Aqeel and Nishat (2004)
positive correlation whereas home market size and empirically identified the variables of FDI growth
domestic market attractiveness had negative in Pakistan for the period of 1961 to 2003. They
correlation with FDI stock. Yol and Teng (2009) used co-integration along with error correction
explored short run and long run domestic variables techniques for identifying factors which influence
affecting FDI in Malaysia through cointegration level of FDI. The results had shown that corporate
econometric analysis covering period of 1975- tax rate, import tariffs, exchange rate, devaluation
2006. The results depicted that GDP, exchange rate of rupee and liberalization measures had positive
and infrastructure positively whereas exports and significant relationship with FDI inflows. Dar
negatively affected FDI in long run. In short run, et al. (2004) analyzed the explanatory variables
GDP, infrastructure and exports negatively which determine the patterns of FDI flows in
whereas exchange rate and openness positively Pakistan for the period of 1970-2002 through
influenced FDI. Sen and Mohsin (2010) examined applying ARDL econometric technique. The
the determinants and problems which decelerated variables which were considered in the analysis
FDI stock in Bangladesh for period from 1986 to consist of economic growth rate, economys
2008. They discovered that inferior infrastructure, openness, stability of exchange rate, interest rate,
urban violent activities, political disturbances, unemployment and political risk index. The
inconsistency of economic policies and authors found that all the variables were significant
bureaucracy were the crucial deterrents of FDI. with expected signs to explain FDI inflows in
Shahrudin et al (2010) analyzed FDI determinants Pakistan. Azam and Luqman (2006) investigated
in Malaysia for period of 1970-2008 by using effects of a variety of economic factors on FDI
ARDL framework. The study established that GDP inflows into Pakistan, Indonesia and India for the
growth rate and money supply had positive and period of 1971 to 2005. The authors found that that
significant correlation with FDI inflows. market size, infrastructure, trade openness,
Wafure (2010) observed the determining factors domestic investment, return on investment had
of Nigerian FDI for period of 1977-2006 through significant and positive relationship while external
employing Error Correction Model (ECM) debt, indirect taxes had significant and negative
technique. The results of the study stated that the relationship with FDI inflows. Azam and Kahttak
host countrys market size, deregulation of (2009) evaluated the influence of political
economy and political instability had a positive instability and human capital on FDI stock in
and significant effect on FDI, whereas the Pakistan for the period ranging from 1971 to 2005
exchange rate had negative and significant by utilizing least square method. This paper found
relationship with FDI. Rihab and Lotfi (2011) a positive and significant relationship between
investigated important variables to determine the human capital and FDI stock, while the
level of FDI for 71 developing countries by relationship between political instability and FDI
utilizing dynamic panel data technique for period was positive but statistically insignificant.
of 2001-2006. They found that GDP, human

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Caspian Journal of Applied Sciences Research, 2(3), pp. 117-127, 2013

Awan et al. (2010) evaluated the FDI rate stability, trade openness and incentives
determinants for period of 1971-2008 by applying provided to investors with inflows of FDI in
co-integration and ECM econometric techniques. Pakistan for the period of 1980 to 2010 through
The authors concluded that Gross Fixed Capital Ordinary Least Squares (OLS) regression
Formation, inflation and level of trade openness technique.
had statistically significant and positive impact on
FDI, whereas, current account balance had 3. MATERIALS AND METHODS
statistically significant and negative impact on FDI
inflows in Pakistan. Awan et al. (2011) studied the The data for the period 1980 to 2010 has been
most important economic determining factors of collected from reports of State Bank of Pakistan
FDI flows within Pakistans commodity producing (SBP), Board of Investment (BOI) Pakistan,
sector for the period of 1996-2008. This paper Economic Surveys of Pakistan, Federal Board of
applied Error Correction Model (ECM) and Co- Revenue (FBR) Pakistan and Federal Bureau of
integration techniques to estimate the explanatory Statistics (FBS) Pakistan, World Bank
factors of FDI inflows. The study found that GDP, Development Indicators, IMF, USDA/ERS
GDP real growth rate in commodity producing International Macroeconomic Database and United
sector, foreign exchange reserves, gross fixed Nations Statistical Division Database. First of all,
capital formation, per capita income and trade descriptive statistics have been calculated for
openness had positive signs with FDI inflows dependent and Independent variables. Correlation
within Pakistans commodity producing sector. matrix has been calculated to analyze the
Hakro and Gumro (2011) observed the prevalence of correlation among the variables. The
determinants of FDI in Pakistan for the period of time series nature of the data has made it essential
1970-2007. Four broad groups of variables had to check the stationarity of the data, therefore,
been tested to determine their relationship with stationarity of the data has been measured through
FDI which consisted of cost related variables Augmented Dickey-Fuller (ADF) Unit Root Test.
(wage rate, foreign exchange rate and interest rate); The Least Squares regression model has been used
factors improving investment environment for measuring the relationship of FDI inflows with
(liberalization and economys openness); macro- cost of war against terrorism, political instability,
economic variables (output growth, human capital, electricity generation, market size, inflation rate,
market size, and infrastructure quality); exchange rate stability, trade openness and
development strategy, political stability, and incentives provided to investors.
cumulative risk rating together with structural The following regression model has been stimated:
shocks related to 1988, Nuclear tests in 1999 and LnFDI = 0 + 1LnTerror + 2Pol + 3LnElec+
event of Sept. 11, 2001. The results suggested that 4RGDP + 5Trade + 6Exch + 7Inf + 8Incen +
the macro-economic factors, cost related factors Ut
and cumulative risk index factors as the key
determinants in short-term analysis. The finding Where:
also suggested that there was a long run LnFDI = Inflows of foreign direct investment in
relationship among FDI, macro economic variables million rupees
and openness. LnTerror = Cost of war against terrorism in
Currently, Pakistan is facing severe problems of million rupees
cost of war against terrorism, political instability Pol = Value of 0 for civilian rule and value
and electricity generation and these factors are of 1 for military rule
expected to affect level of foreign direct LnElec = Electricity production in KWH
investment as foreign investors are losing RGDP = Real growth rate of gross domestic
confidence on Pakistans economic and political product in percentage
environment. After reviewing existing literature on Trade = Trade openness calculated as ratio of
determinants of FDI, it can be observed that there exports to Imports
is a dearth of literature which investigated these Exch = Annual growth rate in exchange rate
variables as determinants of foreign direct of Rupee / $
investment in general and for Pakistan in Inf = Annual rate of inflation in percentage
particular. Therefore, this study for the first time, Incen = 1 for the period of 1989 to 2010, 0
intends to determine the relationship of cost of war otherwise
against terrorism, political instability, electricity
generation, market size, inflation rate, exchange 4. RESULTS

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Talat et al.
Foreign Direct Investment (FDI) in Pakistan: Measuring Impact of Cost of War Against Terrorism, Political
Instability and Electricity Generation

First of all, the time series nature of the data had Therefore, ARMA method was not appropriate in
made it essential to analyze the stationarity of the this case, and consequently, Ordinary Least
variables. Therefore, before estimating the Squares (OLS) regression model had been
regression model, the Augmented Dickey Fuller employed to estimate the relationship of FDI
(ADF) unit root test had been performed to check inflows with independent variables. The values of
the stationarity of the dependent and independent adjusted R-square, log likelihood, F-statistic and
variables. The results of the ADF unit root test had Durbin-Watson statistics had also shown that the
been presented in table 3: results of OLS regression model were better than
The results of table 3 shown that variables of results of ARMA model. Therefore, OLS
Foreign Direct Investment (FDI), electricity estimation results had been presented in the table
generation, real growth rate of GDP, exchange rate 4.
and inflation rate were stationary at level, whereas Estimated results of regression equation
variables for cost of war against terrorism and demonstrated that the value of Adjusted R-square
trade openness were stationary at first difference. was 0.95 which indicated that the independent
After testing stationarity of the variables, the variables in the regression equation had explained
ARMA model had been employed to determine the about 95 percent variations occurring in inflows of
relationship of cost of war against terrorism, foreign direct investment for Pakistan. The value
political instability, electricity generation, real of Durbin Watson statistic for this regression
growth rate of GDP, trade openness, exchange rate model was 2.37 which indicated that the
stability, inflation rate and incentives provided to mathematical form of the regression equation was
investors with FDI inflows in Pakistan. Least accurate and also absence of autocorrelation
Squares method had been used for estimation of among the variables used in the regression
ARMA parameters. The results of ARMA model equation. The value of AIC for this regression
had shown that the moving average term for model was 0.78, which indicated that the model
dependent variable i.e. LnFDI(-1) had insignificant had substantial support for relative goodness of fit
coefficient, indicating that FDI lag value was not and highly capable of being utilized for making
affecting FDI inflows in case of Pakistan. inferences.

Table 3: ADF Stationarity Unit Root Test for Variables


T-ADF
Variables Critical Values Decision
Statistics

1% level = -4.356068
-4.843915
LnFDI 5% level = -3.595026 Stationary at level
(0.0033)
10% level = -3.233456

1% level = -3.679322
-5.444722 Stationary at 1st
LnTerror 5% level = -2.967767
(0.0001) difference
10% level = -2.622989
1% level = -3.670170
-4.488018
LnElec 5% level =-2.963972 Stationary at level
(0.0013)
10% level = -2.621007
1% level = -3.670170
-4.032378
RGDP 5% level =-2.963972 Stationary at level
(0.0041)
10% level = -2.621007
1% level = -3.679322
-5.423869 Stationary at 1st
Trade 5% level = -2.967767
(0.0001) difference
10% level = -2.622989
1% level = -3.670170
-4.113373
Exch 5% level = -2.963972 Stationary at level
(0.0033)
10% level = -2.621007
1% level = -3.711457
-3.753901
Inf 5% level = -2.981038 Stationary at level
(0.0091)
10% level = -2.629906

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Caspian Journal of Applied Sciences Research, 2(3), pp. 117-127, 2013

Table 4: OLS Regression Estimates


Dependent Variable: LNFDI
Method: Least Squares
Included observations: 31 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

LNTERROR -0.009942 0.020866 -0.476471 0.6384


POL -0.586467 0.301843 -1.942954 0.0649 ***
LNELEC 2.524508 0.315306 8.006535 0.0000 *
RGDP 0.097663 0.035629 2.741119 0.0119 **
TRADE 0.126975 0.026525 4.786925 0.0001 *
EXCH 0.023206 0.011460 2.024926 0.0552 ***
INF 0.016170 0.026123 0.619001 0.5423
INCEN 1.037961 0.384701 2.698095 0.0131**
C -25.24071 3.419254 -7.381934 0.0000*

R-squared 0.966203 Mean dependent var 5.965065


Adjusted R-squared 0.953913 S.D. dependent var 1.478668
S.E. of regression 0.317437 Akaike info criterion 0.780626
Sum squared resid 2.216859 Durbin-Watson stat 2.366091
Log likelihood -3.099705
F-statistic 78.61873
Prob(F-statistic) 0.000000

* Significant at 1 Percent.
** Significant at 5 Percent.
*** Significant at 10 Percent.

The estimated results had shown that the cost of environment, therefore, foreign investors were
war against terrorism had a negative sign as hesitating to make investment in Pakistan because
expected which was consistent with results of of political instability.
Agrawal (2011) who investigated the impact of The electricity generation was positively and
terrorism on FDI inflows and reported that significantly affecting the inflows of FDI in
transnational terrorism events negatively affect Pakistan as expected. The high coefficient for
total FDI inflows in developed countries. In case of electricity generation indicated the magnitude and
Pakistan, this variable had insignificant effect of electricity generation for attracting FDI
relationship with inflows of FDI which might be inflows. Pakistan was continuously unable to
due to the fewer observation for cost of war against generate sufficient quantity of electricity to fulfill
terrorism for 10 year i.e. from year 2001 to year the existing demand for electricity. The shortfall in
2010. However, it confirmed the expectation that it the supply of electricity resulted in electricity load
is one of the major hindrances in attracting shedding and causing all sorts of troubles for
overseas investors and foreign direct investment in businesses as well as residents of Pakistan. The
Pakistan as the foreign investors were facing business and industrial units were not able to
security threats and they are also uncertain about survive and a large number of businesses were
return on their investment. shutting down their production units resulting in
The results also revealed that political outflows of capital investment from Pakistan.
instability had a negative and significant affect on The market size had significant and positive
inflows of FDI as anticipated. This result was role in attracting inflows of FDI into Pakistan. This
similar to the results of Azam and Khattak (2009). result is consistent with findings of Azam and
The investors made investment in only those Lukman (2006), Awan et.al. (2010) and Azam et.
countries where they believed that their capital al., (2011). The estimated results further revealed
investment and return on that investment would be that trade openness of the Pakistans economy also
safe and sound. But unfortunately, Pakistan had a positive and significant relationship with
constantly faced the dilemma of instable political inflows of FDI in Pakistan. This finding

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Talat et al.
Foreign Direct Investment (FDI) in Pakistan: Measuring Impact of Cost of War Against Terrorism, Political
Instability and Electricity Generation

corresponds with findings of Dar et.al. (2004), The regression diagnostics have been estimated
Azam and Lukman (2006) and Awan et.al. (2010). to verify and support the regression results. First of
Moreover, the estimated results also disclosed that all, normality of the data has been tested through
exchange rate stability had a positive and One-Sample Kolmogorov-Smirnov Test. The
significant effect on FDI. This result is in align results have been shown in table 5:
with the findings of Aqeel and Nishat (2004) and The results of One Sample Kolmogorov-
Dar et.al. (2004) that appreciation of exchange rate Smirnov Test indicates that the data has normal
encourages FDI within host economy. distribution because the P-Value is 0.949 which is
Another finding of regression results was that greater than 0.05, therefore, the hypothesis
the fiscal incentives provided by the Pakistani regarding normality of data has been accepted. As
government were positively associated with mentioned above, the value of Durbin-Watson
inflows of FDI, was significantly attracting FDI. Statistics is 2.366092 which depicts that that the
This finding corresponds with results of Aqeel and observations are independent of each other as the
Nishat (2004) and Wafure and Nurudeen (2010). values is within acceptable range of 1.5-2.5.
Finally, the variable of inflation rate had positive Secondly, to check collinearity of predictors,
association with inflows of FDI which was Variance Inflation Factor (VIF) Values have been
contrary to its expected sign but this relationship estimated and the results have been shown in table
was statistically insignificant. This finding is 6:
consistent with the findings of Azam and Lukman
(2006).

Table 5: One-Sample Kolmogorov-Smirnov Test


Unstandardized Residual
N 31
Normal Parametersa Mean .0000000
Std. Deviation .27183687
Most Extreme Differences Absolute .094
Positive .092
Negative -.094
Kolmogorov-Smirnov Z .521
Asymp. Sig. (2-tailed) .949
a. Test distribution is Normal.

Table 6: Coefficients Table


Variable Collinearity Statistics
Tolerance VIF
LnTerror .208 4.811
Pol .147 6.825
LnElec .097 9.305
RGDP .706 1.417
Trade .221 4.518
Exch .669 1.495
Inf .320 3.127
Incen .107 9.381
a. Dependent Variable: LnFDI

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Caspian Journal of Applied Sciences Research, 2(3), pp. 117-127, 2013

The results of Variance Inflation Factor (VIF) Thirdly, Pakistan should take some effective
have shown that the predictors dont have problem measures to increase electricity generation on
of collinearty because the VIF Values for all the urgent basis for improving economic conditions of
predictors are less than 10, so it indicates that all the country. The government should immediately
the predictors are acceptable. Thirdly, the results of formulate policies aimed at increasing electricity
Studentized (Residuals) test have shown that there generation and implement these policies
is no outliar value in the data because all the values effectively to restore investors confidence. It will
are within acceptable range of -3 to +3. Finaly, assist in improving economic and financial
results of Cook-D Test have shown that there is no conditions and also attract domestic and foreign
influential value in the data as all values are less investors to make investment in Pakistan. Fourthly,
then acceptable value of 1. the market size is also a very important variable for
increasing inflows of FDI in Pakistan. Larger
5. DISCUSSION market size and increasing GDP growth rate
indicates better market opportunities for foreign
This study has investigated the determinants of investors to earn greater investment returns.
FDI in Pakistan including cost of war against Therefore, efforts should be made to increase
terrorism, political instability, electricity market size and GDP growth rate for attracting
generation, real growth rate of GDP, tradeopeness, overseas investors.
exchange rate stability, inflation rate and Finally, the exchange rate of Pakistani rupee
incentives provided to investors for the period should be strengthened in order to lure the foreign
1980 to 2010 based on time series data. The results investors and to attract more inflows of foreign
indicate that the electricity generation, political direct investment. Finally, more fiscal incentives
instability, market size, trade openness, exchange should be offered to the foreign investors along
rate stability and fiscal incentives provided to with further deregulation of the economy for
investors have significant and positive relationship attracting inflows of FDI in Pakistan.
with inflows of foreign direct investment whereas Although this empirical investigation has
variables for cost of war against terrorism and produced very interesting results however, there
inflation rate have insignificant relationship with are few limitations of the study. The data for cost
foreign direct investment. of war against terrorism in Pakistan has been
The main contribution of this study is to available only for the period of 2001-2010. Some
investigate, for the first time, the relationship of other appropriate proxy for cost of war against
cost of war against terrorism, political instability terrorism in Pakistan can be used in the analysis
and electricity generation with FDI inflows in for a longer time period. The dummy variable has
Pakistan since these variables have not yet been been used in the regression model for measuring
focused in the existing literature. The estimated the political stability in Pakistan. Some other
results have shown that these variables are quantifiable proxy may be used for measuring
affecting, as expected, FDI inflows in Pakistan. political stability.
Therefore, these variables need to be focused in
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