Stock Market and Fdi

Topics: Investment, Economics, Macroeconomics Pages: 13 (4758 words) Published: July 6, 2013
Journal of Economics and Behavioral Studies Vol. 4, No. 1, pp. 26-33, Jan 2012 (ISSN: 2220-6140)

The Role of FDI on Stock Market Development: The Case of Pakistan *Ali

Raza, Nasir Iqbal, Zeshan Ahmed, Mohammad Ahmed, Tanvir Ahmed Hailey College Of commerce, PU Lahore, Pakistan *aliraza_ghuman01@yahoo.com

Abstract: The purpose of this study is to empirically analyze the role of foreign direct investment in developing host country’s stock markets and to examine whether they are related or not. The key interest turns around the admiring role of FDI in Stock market development of Pakistan. Our work also aims to investigate the effect of foreign direct investment along with domestic savings, exchange rate and inflation in developing Pakistan stock markets in a rapidly changing political environment. This study applies Ordinary Least Square (OLS) method of regression by using annual time series data for the period 1988-2009 in case of Pakistan to estimate empirical relationships among variables. The results disclose a positive impact of foreign direct investment along with other explanatory variables in developing Stock markets of Pakistan. The study findings can be used to help government policy makers to encourage FDI and take various steps to provide incentives and save foreign investors interest in a volatile political environment that prevailing in the country. Adequate facility of infrastructure can enhance FDI. The volatility of exchange rate and inflation rate should also be minimized through monitory policy while domestic savings must also be encouraged in the country through appropriate and encouraging saving policies. Our effort exclusively study development of Stock markets in Pakistan with special reference to foreign direct investment and other variables. Our study depicts a closer relationship between FDI and Stock Market Development. Keywords: Stock Market Development, FDI, Exchange Rate, Domestic Savings, Inflation Rate, Pakistan 1. Introduction A very important and integral part of a country’s financial system is the stock market and a strong financial system guarantees the financial development and growth of that country. A well organized and managed stock market encourage investment by identifying and supporting that productive projects that will ultimately lead to economic development .The stock markets are the best indicators to estimate future economic activity and stock market health is also a measure of economic strength of a country .In order to boost economic development of a country the development of stock market is vital. The Islamic Republic of Pakistan is a country situated at an intersection of three major counties of Asia. It is a developing, lower middle-income country with GDP per capita $2500, and have a population of 187 million. The Karachi stock exchange (KSE) is the oldest stock exchange of Pakistan established in 1947. The other stock exchanges of the country include Lahore stock exchange (LSE) and Islamabad stock exchange (ISE) established in 1974 and 1997 respectively. According to a recent survey, about 80 to 85 percent of turnover occurs at KSE with average daily turnover of 145 million shares. Figure1 shows an increasing trend in stock market capitalization for the year 2001 to 2007, all this due to stability in political and economic sector. However, the growth slows down after 2007. However, with the help of standby agreement with IMF in 2008, the country’s foreign reserves increased and current account stabilizes. According to a report released in 2011 by the World Bank the market capitalization of listed companies in Pakistan increased to $38168586546 in 2010.Given the importance of Stock markets and its downward trend over the last few years this study also attempts to examine the factors that also affects stock market capitalization in Pakistan. A major source of investment inflow for a developing country is foreign direct investment. FDI provides a passage for...

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