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The Impact of the Real Interest Rate, the Exchange Rate and Political Stability on Foreign Direct Investment Inflows: A Comparative Analysis of G7 and GCC Countries

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Abstract

Sustainable financial development plays a vital role in new institutional economics and transaction cost economics. This asserts the important role of interest and exchange rates and political stability as determinants of an economy’s institutional quality. The current study aimed to investigate the effects of the real interest rate, the exchange rate and political stability on foreign direct investment (FDI) inflows in G7 and Gulf Cooperation Council (GCC) countries from 2005 to 2019. The panel fully modified least square and panel dynamic least square estimators used in this study revealed a significant positive long-run relationship between the real interest rate and FDI inflows in the G7 and GCC countries. In addition, there was a significant negative long-run relationship between the exchange rate and FDI inflows in the G7 countries; this relationship was insignificant in the GCC countries. There was also a significant negative long-run relationship between political stability and FDI inflows in the GCC countries; this relationship was insignificant in the G7 countries. The panel least square method confirmed the results of the previous two estimators for the real interest rate and FDI inflows in the G7 countries. Based on these findings, to increase FDI inflows, efforts should be made to lower the lending interest rate and enhance capital formation and trade. Furthermore, market forces should be allowed to determine the real interest rate, and monetary policy should focus on developing a systematic exchange rate to promote political stability and the sustainability of foreign investment in developed and developing countries.

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Data Availability

World Development Indicators (WDI) (2019). Retrieved on 01-04-2020 from: https://databank.worldbank.org/source/worlddevelopment-indicato. Worldwide governance indicators (WGI) (2020). Retrieved on 01-04-2020 from http://info.worldbank.org/governance/wgi/

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    Faris Alshubiri

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Appendix: Definitions of the Variables

Appendix: Definitions of the Variables

Variable

Abbreviation

Definition

Source

Independent variables

Real interest rate (%)

RINT

This variable expresses the lending interest rate and is an inflation-adjusted measure that is calculated using the GDP deflator

World Development Indicators (2019)

Real effective exchange rate index (2010 = 100)

EXCR

This variable is the nominal effective value of the exchange rate, which is expressed by the value of the currency against different foreign currencies divided by the cost index or a price deflator

World Development Indicators (2019)

Political stability

POLST

This variable expresses the forms of political stability in a country, includes the disappearance of politically motivated manifestations of violence and terrorism and is measured from + 2.5 (the maximum strong indicator of governance) to  − 2.5 (the maximum weak indicator of governance)

Worldwide Governance Indicators (2020)

Dependent variable

Foreign direct investment, net inflows (% of GDP)

FDI

This variable is the net investment flows in economic operations and includes forced and long-term capital and reinvestments

World Development Indicators (2019)

Control variables

Gross capital formation (% of GDP)

GRCF

This variable is an expression of total local investment and comprises fixed assets and changes in inventory

World Development Indicators (2019)

Inflation, consumer prices (annual %)

INFL

This variable reflects changes in the consumer cost of a basket of goods and services, which can be expressed in a specific range

World Development Indicators (2019)

Trade (% of GDP)

TRD

This variable is the total exports and imports of goods and services, which are expressed as a percentage of the gross domestic product

World Development Indicators (2019)

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Alshubiri, F. The Impact of the Real Interest Rate, the Exchange Rate and Political Stability on Foreign Direct Investment Inflows: A Comparative Analysis of G7 and GCC Countries. Asia-Pac Financ Markets 29, 569–603 (2022). https://doi.org/10.1007/s10690-022-09360-0

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  • DOI: https://doi.org/10.1007/s10690-022-09360-0

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