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Abstract
In this paper, we perform empirical analysis on how Foreign Direct Investment (FDI) can impact negatively on the Current Account Balance of Pakistan; at the same time generating positive results for GDP. We emphasized the Granger causality test and impulse response function to analyze the dynamic influence of FDI on current account balance. The results suggest that FDI has a negative effect on current account and a positive affect on GDP.
Keywords: Empirical Analysis; FDI; Current Account Balance, Granger Causality
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Introduction
Pakistan's foreign policy and investment regime have changed substantially post reform era hence witnessing a steady growth in FDI during past few years. The evidence is mixed on existence of positive spillover effects of FDI for a host country, yet the positive role of FDI is well documented in literature. The economic growth of the country is positively associated with the level of FDI inflows and FDI trends to be directed to those countries and sectors that enjoy actual and potential comparative advantage. This growth in FDI may be attributed mainly to macroeconomic reforms by the government.
Modern empirical literature draws a forgone conclusion that FDI in one way or the other benefits the host country, thus enhancing the overall development of the country, especially a lower developed country like Pakistan. Pakistan is among those countries who have been suffering from the problem of current account deficit and it has become chronic over many decades. Since independence, Pakistan has been facing problems regarding trade and current account deficits which pose both a short term risk and long term problem. At present, Pakistan is financing the large current account deficit with huge flows of workers remittances and foreign direct investment. If the flows of workers remittances and foreign direct investment decline, it will create a serious problem for Pakistan to finance the large current account deficit.
For Pakistan most studies concluded that FDI had a positive affect on economic development, because mainly the studies have focused on how to generate conditions to attract more FDI, rather than the negative effects for the host country.
The benefits of FDI have been confirmed by actual behavior which "ignores inconclusive academic literature" (Lipsey, 2006, 1), positive externalities continue to be publicized...