A STUDY ON DESIRABILITY OF FOREIGN DIRECT INVESTMENT POLICIES: WITH SPECIAL REFERENCE TO SRI LANKA

Abstract

Foreign Direct Investments (FDI) contributes to the economic growth and development of developing countries in numerous ways. Recognizing this potential, policymakers selected several strategies to encourage Foreign Direct Investments inflows to Sri Lanka as well. Unanimous decision to join South Asian Free Trade Area (SAFTA) and attempts taken to improve the institutional excellence are considered as two such policy decisions taken in the context of Sri Lanka. However, flattered trends in FDI inflows to Sri Lanka over the years question the desirability of such selected strategies. Therefore, it is imperative to study whether SAFTA and prevailing Institutional Excellence in the country have the potential of attracting FDIs. With the presence of significant co integration among the endogenous determinants of FDI inflows considered with this study, Vector Error Correction Model (VECM) has been employed over the period 1996 to 2019. As SAFTA is a dummy variable, to measure its significance an unrestricted VECM has been compared with the base model using LM test. Finally, a time series Autoregressive Moving Average – Generalized Autoregressive Conditional Heteroskedastic (ARMA-GARCH) regression model is used to robust the results obtained for the base models. The results of VECM revealed that, both SAFTA and institutional excellence adversely affect FDI inflows. However, the effect of institutional excellence was statistically significant while the effect of SAFTA was not statistically significant in the robust model. One of the objectives of entering into SAFTA is to expand the country's market size and thereby encourage foreign investments. However, results supported the other. This may be mainly due to market size expansion effect expected from SAFTA was not significant for SriLanka. Similarly, Institutional Excellence in the country appears like hindering FDI inflows. Instability in macroeconomic factors like central bank independence, exchange rate, interest rate might have led to this