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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

Faris Alshubiri ()
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Faris Alshubiri: Dhofar University

Asia-Pacific Financial Markets, 2022, vol. 29, issue 3, No 7, 569-603

Abstract: 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.

Keywords: Interest rate; Exchange rate; Political stability; Foreign direct investment inflows; International Fisher effect theory; Purchasing power parity theory (search for similar items in EconPapers)
JEL-codes: E40 E43 E62 F21 F31 P52 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10690-022-09360-0

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Handle: RePEc:kap:apfinm:v:29:y:2022:i:3:d:10.1007_s10690-022-09360-0