Nexus between FDI and foreign aid: The case of five south Asian economies

Abstract

This study investigates the nexus between foreign direct investment (FDI) and decomposed Official Development Assistance (ODA) in five South Asian countries. Following economic reform and improving FDI policy fame work in 90s, the South Asian region becomes as an important destination for investment. Indeed, this region is also destination of official development assistance for several years that directed by donors in order to reach various objectives. Both FDI and official development assistance are seen capital flows can develop physical and human capital in host countries, but at the same time both can effect on each other in the way of the sense that complementary and substitutes. Thus, this study investigates the nexus by employing cointegration and Granger causality tests in five South Asian countries. Using cointegration test we empirically found that there is a long-run relationship between FDI and official development assistance for physical capital development in Nepal, Pakistan, India and Sri Lanka, but not in Bangladesh, while the relationship between FDI and assistance for human capital and infrastructure development is in Bangladesh, Nepal, India and Sri Lanka, but not in Pakistan. Granger causality tests suggest that receiving assistance for human capital and infrastructure development working towards attracting FDI in South Asian countries. The argument that official development assistance for physical capital development crowds out FDI is weak in case of South Asian countries. Conclusively we suggest that receiving foreign aid in the shape of human capital and infrastructure development encourages FDI in South Asian region.