econometric analysis of factors affecting foreign direct...

Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB)

An Online (Double-Blind) Refereed Research Journal (ISSN: 2306-367X)

2018 Vol: 7 Issue: 1

2570 www.globalbizresearch.org

Econometric Analysis of Factors affecting Foreign Direct

Investments: Kingdom of Saudi Arabia (1983-2013)

Haga Abdelrahman Elimam,

Faculty of Economics and Administration,

University of King Abdul Aziz,

Jeddah, Saudi Arabia.

E-mail: [email protected]

Sanaa Mohamed AlyHelal,

Faculty of Economics and Administration,

University of King Abdul Aziz,

Jeddah, Saudi Arabi.

E-mail: [email protected]

___________________________________________________________________________

Abstract

This study has aimed to identify and estimate different economic factors that affect the flow of

direct investments in Saudi Arabia. Descriptive and analytical approach has been used to

study the policies, regulations, and development of foreign direct investment in Saudi Arabia

between 1983 and 2013. Results have revealed that the economic variables contribute

significantly on the FDI over the period. Saudi Arabia comprises about 60.3% of the total

foreign investment and has a positive impact on the economic development within the host

country.

___________________________________________________________________________

Key Words: Foreign Direct Investment, Economic Development, Inflation Rate, Saudi Arabia

mailto:[email protected]





1. Introduction

Investments represent the major economic activity of any country. It is known as a

significant factor that leads to economic development. Lack of national savings directly

affects the capital, which eventually results in decreased Gross Domestic Product (GDP). The

foreign direct investment (FDI) is one of the important characteristics of international

economic relations that play an important role in the overall development of different

countries (Almfraji & Almsafir, 2014). It is defined as a long-term investment made by

foreign investor in domestic country that has the ability to get return in term of retained

earnings (Asaf-Adjei, 2007). It is responsible for securing the economic growth, thus

promoting a country’s financial performance and technical modernization of the country

(Mallampally & Sauvant, 1999).

Investments fulfil the basic needs of developing countries which is suffering from

financial crisis due to scarcity of capital and lack of technical and scientific advancement. FDI

positively contributes towards the improvement of balance of payment through increase in the

export opportunities and decrease in flow of foreign capital and imports. Therefore, the

developing countries are urged to adopt different procedures and policies to attract investment

towards wellbeing of their economy. This procedure is carried out together with the priorities

system, which leads to successful economic development. Saudi Arabia is amongst such

countries, which secured their investment for an appropriate economic and non-economic

climate and handled the FDI (Gilpin, 2016).

Saudi Arabia possesses abundant resources and has made ample efforts since last century

to create a suitable and effective environment to attract maximum foreign investments. Saudi

Arabia intends to increase its efficiency by increasing its investment activity in private and

public sectors. This has been attributed to different challenges experienced by the economic

development of the country associated with the flow of foreign direct investment. Saudi

Arabia has set different targets and policies after creating an efficient economic and political

environment for foreign investment. The investment environment is affected by various

economic, social, and political factors that are associated with the FDI (Mathur & Singh,

2013). It is important to identify such indicators that are responsible for affecting FDI, which

comprises the investment environment. Therefore, this study has been conducted to identify

the significant economic factors that influence FDI. Moreover, the study has also made an

attempt to highlight the factors that stimulate the flow of FDI.

Saudi Arabia adopts several forms and images on the basis of domestic funding sources

required for various development projects to increase economic growth of the country. The

investments are responsible for increasing employment opportunities and raise the

productivity of institutions as well as individuals. The economic growth of any country is





directly associated with its dependency on external funding sources, say FDI. The FDI

contribute towards the compensation of lack of domestic savings and investment. It assists

and helps the country to acquire productive, managerial, and marketing abilities. However,

FDI flows to Saudi Arabia have followed a downward trend in last two years. According to a

report by the UN Conference on Trade and Development (UNCTAD), investments from

abroad in Saudi Arabia fell 80 percent in the year 2017, amounted to just $1.4 billion, down

as much as from $12.2 billion in 2012 (UNCTAD, 2017).

The report also noted that FDI to Saudi Arabia has been contracting since the global

financial crisis in 2008-09 (Forbes, 2018). According to an investment monitor owned by

the Financial Times, there were only 58 foreign projects in 2017 compared to a high of 140 in

2011 and that investment from Western Europe and the US fell by $144 million and $457

million, respectively. Anyhow, the declining trend in FDI is a very risky development,

especially when other components of the balance of payments are also showing deteriorating

trends. This escalation in FDI might be credited mainly to macroeconomic improvements and

political stability of the government (Khan, 2007). Thus, there is need of a study that focus on

improving the FDI by examining the vital macro-economic variables that may impact on FDI

in Saudi Arabia. Figure 1 shows the FDI net flows in Saudi Arabia.

Figure 1: FDI Net Inflows (% of GDP) in Saudi Arabia (1980-2016)

Source: World Bank Indicators

According to Frenkel, Funke and Stadtman (2004) FDI can speed up growth by producing

employment opportunities in the host countries, creating demand for huge investment,

covering savings gap and sharing management skills and knowledge through forward and





backward relationships in the host countries. FDI improves organizational restructuring,

capital stock, transfer of technology and productivity. Ultimately, it results in augmentation in

the growth of host countries. FDI is a key factor in augmenting growth of host country and it

leads to growth only when its inflows are managed properly (Bezuidenhout, 2009). Therefore,

this study using quantitative analytical method has made an attempt to figure out the

determinants of FDI in Saudi Arabia. The relationship between different economic factors

affecting FDI has been analysed in the public budget positions in Saudi Arabia for the period

1983 to 2013.

The rest of the paper is organized as follows: Part two reviews the relevant literature on

FDI across the world and Saudi Arabia along with theoretical developments. Part three

provides the methodology for conducting the research. Part four presents the empirical

findings while the final part encompasses conclusion and managerial implications drawn from

this study.

2. Literature Review

Saudi Arabia depicts special interest in FDI because it plays a significant role in

supporting the economy of the country. It bridges the gap between the requirement of national

resources and size of the local resources in the country. Saudi Arabia has been considered

among the countries, attracting FDI globally and possesses factors for the establishment of

appropriate environment for creating such foreign investments (Hasli et al., 2016). Previous

literature on the role of FDI in economic development in context of Saudi Arabia and across

the globe between the years 1983 to 2015 has been included in this chapter.

2.1 Ideology of Foreign Direct Investment

FDI is defined as a long-term investment made by foreign investor in domestic country

that has the ability to get return in term of retained earnings (Asaf-Adjei, 2007). United

Nations Conference on Trade and Development (UNCTAD) defined FDI as the type of

investment that is associated with long term relationship, reflecting the permanent interest and

ability of the administrative control (Amir, 2016). The administrative control needs to be

efficient in the production unit of the company. FDI involves long term association, reflecting

the permanent interest among the production unit of different companies (Dur et al., 2014).

Thus, as compared with domestic investment, FDI is said to be more productive in the sense

that it will bring value-added to the host country (Lim, 2001).

In addition to economic performance, FDI is also helping the host nation to improve its

economic condition by promoting new job opportunities for local unemployed (Stamatiou &

Dritsakis, 2013). It is because during the FDI inflows, foreign investors will tend to set up

new factories and plants in the host country and thus lead to the creation of new job

vacancies. It is known as a stable and reliable investment activity, which provides investors





certain assets to run the processes efficiently in other countries. It is considered as a stable

investment activity within any country in which the investor acquires different assets in other

countries for efficient running of the investments (Nayak & Choudhury, 2014). Therefore,

FDI plays an important role in boosting up economic growth and help to develop the host

country (Pegkas, 2015).

2.2 Previous Studies

According to Dabour (2000), FDI played a significant role in either the global economy or

even the economy of a country by creating new business opportunities that lead to decrement

in unemployment, enabling transformation of technology in production, gained management

knowledge that is more advance, easy access to foreign market, improve standard of living

and competition increment. Dar (2015) argued that FDI was a type of international investment

that was a type of relatively more stable financing source for a nation by inducing the long

term of capital inflows into the host country. FDI is considered as a worthy option for the

countries, experiencing external indebtedness and financial crisis (Demi,rhan & Masca,

2008).

Saqib, Masnoon and Rafique (2013) focused on the contrasting evidence in the literature

affecting to the impact of FDI on the host country’s economy, it used the least square method

to test the impact of these variables from 1981-2010. The study focused on different variables

like FDI, debt, trade, inflation and domestic investment. It used the augmented dickey fuller

test. A study conducted by Ahn, Adji, & Willett (1998) to investigate the relationship between

the inflation, rate of foreign exchange and FDI inflow among twenty three developing

countries, the study concluded that higher inflation rate has an adverse effect on FDI inflow in

the country, the research indicated this effect can be significantly reduced but not eliminated.

Another study conducted on various macroeconomic variables relationship with FDI

resulted that there is a great need for improving the locational factors in Pakistan for attracting

the foreign investors, the study also find that the political stability, exchange rate stability and

high and stable growth are the main areas of concern to attract the more foreigners for direct

investment (Akhtar, 2000). FDI offers joint production between the foreign company and the

developing country, on the basis of high quality scale and massive production. It extensively

reduces the problem of unemployment by securing various job opportunities and contributes

towards the improvement of salaries and wages. A great breakthrough towards the existing

foreign markets can be achieved by the economic integrations including European Common

Market, which encourages the factors for maximum foreign direct investment (Tilly &

Welfens, 2013).

There are many researchers found out that economic growth rate was a key determinant to

attract more FDI (Al-Iriani & Al-Shamsi, 2007; Al-Nasser, 2010; Jimenez, 2011). According





to Hansen and Rand (2006), rapid growth rate of an economy might attract more FDI due to

high profitability. Moreover, Iamsiraroj and Doucouliagos (2015) had stated that a low

economic growth implied that greater opportunities for future earning and hence there would

be a negative association between economic growth and FDI. FDI can speed up growth by

producing employment opportunities in the host countries, creating demand for huge

investment, covering savings gap and sharing management skills and knowledge through

forward and backward relationships in the host countries (Frenkel, Funke and Stadtman,

2004).

According to Bilawal et al. (2014), exchange rate has positive effects on FDI, when the

Pakistan currency exchange rate is high, which meant that the company would gain more

currency from investment and it would help the company to earn high foreseen profits.

Furthermore, Campa (1993) stated that the currency of host countries appreciated would

increase FDI inflows. Nevertheless, Athukorala (2003), Khan and Nawaz (2010), Sharifi-

Renani and Mirfatah (2012), Kim, Lee and Lee (2015) found out that there is negative

relationship between exchange rate and the level of FDI.

FDI attracts different representations in the provision of financial incentives including;

decreased interest rates, credit facilities, assistance from revenue subsidy, decreased taxes,

and tax exemptions. About 70% of the foreign direct investments are attracted by the

developed countries; while, 30% is directed towards the developing countries (Inderst &

Stewart, 2014). In the context of determinants of foreign direct exchange, international

organizations have identified few aspects: a) size of domestic market calculated by GDP of

the host country, b) economic growth rate measured by growth rate of real GDP, and c)

average per capita income measure effective demand for services and goods

According to Asaf-Adjei (2007), FDI is known as the fastest growing and strategic

activities that majority business organizations pursue all over the world in 1991. Besides, the

importance of FDI is also well described by Mallampally and Sauvant (1999) for which FDI

was having highly positive influence on economic growth thus promoting a country’s

financial performance. According to Dabour (2000), FDI played a significant role in either the

global economy or even the economy of a country by creating new business opportunities that

lead to decrement in unemployment, enabling transformation of technology in production,

gained management knowledge that is more advance, easy access to foreign market, improve

standard of living and competition increment.

From literature, the economic factors responsible for affecting FDI include economic

structure, economic policies, country’s developments, and abundance of natural resources.

However, the increase in political and economic stability of country leads to increase flow of

investments. Although, the FDI possess various incentives, taxes, and custom exemptions, but





it is not beneficial for the developing countries despite the fact that the developing countries

suffer unstable monetary policy, high rate of interest, huge financial deficit, instability in the

exchange rates, and conflicting exchange policies (Marcelin & Mathur, 2016).

3. Methodology

This research study is quantitative in nature. The study has made an attempt to examine

the relationship between foreign direct investment (FDI) and different macro-economic

indicators in the context of Saudi Arabia. The data is collected from secondary sources and is

collected from World Bank indicators. The data is taken annually from 1983 to 2013 for

conducting the study. FDI are taken as dependent variable, whereas GDP, exchange rate,

loans from financial institutions, degree of economic openness, and inflation rate are taken as

independent variables. The collected data has been analysed using SPSS v20.0. Multiple

regression technique is used to assess the impact of independent variables on the dependent

variable along with descriptive statistics. Most of the variables used in this study are planned

according to the variables that had already been used in earlier researches.

Table 1: Variables Proxy

Variable Proxy Reference

FDI Foreign Direct

Investment inflows

Jongwanich (2007); Khan, Mughal, Ahmed & Cai (2017)

GDP Gross Domestic Product Habib and Nourin (2006); Lueth and Ruiz-Arranz (2007);

Paranavithana (2014)

INFL Inflation Rate (%) Hunjra et al. (2014)

LFI Loans from Financial

Institutions

Alaro et al. (2004); Cheng and Degryse (2010)

OPT Degree of Economic

Openness

Alaro et al. (2004)

EXR Exchange Rate Takagi & Shi (2011); Sharifi-Renani & Mirfatah (2012);

Kim, Lee and Lee (2015)

Multiple Linear regressions follow the assumptions of OLS estimator which are linear,

unbiased, efficiency and consistent, also known as BLUE (best linear unbiased estimator).

Under panel data regression, OLS ignore the panel structure of data and form it as a simple

and general regression model. The regression equation is as follow:

Y = + β1X1+ β2X2 + β3X3 + β4X4 + β5X5 + €

Where,

Y = Foreign Direct Investment

= Constant slope intercept

β1- β5 = Coefficient for the independent variables

X1 = Gross Domestic Production Growth (%)

X2 = Exchange Rate

X3 = Inflation Rate (%)

X4 = Loans from Financial Institutions

X5 = Degree of Economic Openness

€ = Error term





3.1 Research Questions

The study addresses the following research questions;

What are the factors that affect the FDI’s in Saudi Arabia?

What are the important characteristics used for creating suitable atmosphere for

FDI?

What are the obstacles faced by the FDI in Saudi Arabia?

4. Results and Discussion

FDI inflow in Saudi Arabia have commenced since the beginning of the 17th century.

Saudi Arabia comprises about 60.3 percent of the total foreign investments received by the

countries of Gulf Cooperation Council. The results have highlighted various aspects regarding

economic growth of the country, through evaluation of impact and importance of FDI in

economic development of developing countries. It is believed that FDI positively influences

economic development in Saudi Arabia. Table 2 provides the descriptive statistics of the

dataset.

Table 2: Descriptive Statistics

Mean Std. Dev. Kurtosis Skewness

FDI 8.729 0.588 -0.702 -0.187

GDP 4.901 2.099 -0.175 0.209

EXR 125.602 37.626 1.114 1.532

INFL 11.227 2.064 0.54 0.655

OPT 0.105 0.311 3.464 1.679

LFI 282.771 0.563 2.798 1.845

The findings of the regression model are as follow:

The results indicated that certain interpretive variables comprising the economic openness

rate, GDP, and loans granted by the financial institutions are similar to the assumptions of the

economic theory. The value of determination coefficient (R-square = 0.709) suggested that

the explanatory variables contributed in the conduct of foreign direct investments in Saudi

Arabia. Moreover, the value of F test that is F = 12.68281 showed high statistical

significance; whereas, self-correlation coefficient that is D.W. = 1.818681 showed there is no

issue of correlation among the residuals.

The results indicated that the FDI in Saudi Arabia increases by 2.2% as a result of

increase in the economic openness rate by 1%. However, increase in the inflation rate by

100% subsequently increases the rate of foreign direct investment by 20%. On the contrary,

the increase in GDP by 1 % is responsible for decreasing the FDI in Saudi Arabia by 1.7%.





The common integration test revealed that the percentage of greatest potentiality is greater as

compared to the critical value at the level of 5% for all the variables (Table 3). This indicated

the presence of long-term balanced association between different factors, affecting the FDI.

Table 3: Common Integration Test

Test of Impact Maximum Value Test

Vector Value Impact value Critical Value Maximum value Critical value

0.759208 126.1371 95.75366 42.71469 40.07757

0.684325 83.42240 69.81889 34.59122 33.87687

0.533242 48.83118 47.85613 22.85832 27.58434

0.299069 25.97286 29.79707 10.66037 21.13162

0.229996 15.31249 15.49471 7.840775 14.26460

0.220465 7.471719 3.841466 7.471719 3.841466

The statistical results presented in the form of determination coefficient (70%) indicated

that the explanatory variables interpret different changes associated with the factors affecting

FDI in Saudi Arabia. The joint integration test results depicted no positive correlation

between the foreign direct investments and GDP, exchange rate, loans from financial

institutions, degree of economic openness, and inflation rate. However, the openness rate with

the foreign direct investment is dependent on the economic and political stability of the

country.

Saudi Arabia has successfully established General Authority for Investment, which has

been issued with new foreign investment legislation, amended various relevant laws, and

developed strategies to attract maximum foreign direct investment. The results have revealed

that the FDI is influenced by the economic openness rate, inflation rate, GDP, exchange rate,

and loans from various financial institutions. Eventually, it opens the prospect of having

access to difficult markets, needed by the developing countries for the effective

implementation of developmental programs (Marcelin & Mathur, 2016).

The investment rate depends on the rules, regulations, and controlling principles that are

developed by the host countries. Therefore, foreign direct investment helps them to achieve

maximum benefits (Efobi et al., 2014). The local and regional needs are fulfilled by taking

advantage of the advanced research centres and high skills by the foreign investors in

different countries. The significant factor for directing investment is associated with the

difference in production cost in the investing and host countries, which depends on the

relative merits available in the host country.

An organization improves the status of balance of payments by increasing its export

opportunities and reducing the imports, which directly affects the flow of foreign capital

within the country (McCombie & Thirlwall, 2016). New foreign investment projects are

supported by increasing the contribution towards the private sector in the GDP and create a

new class of business for economic growth of the country. However, different laws and





policies of the host country have a great impact on the foreign direct investment (Lee et al.,

2014).

The low economic growth rates and cost of production within the industrialized countries

is responsible for attracting the FDI in the developing countries. However, it is also believed

that the political situation within a country greatly affects the flow of FDI within the country

(Kim & Li, 2014).

5. Conclusions and Recommendations

The impact and significance of FDI depends on different economic situations prevailing in

the country. The FDI has a positive impact on the economic development within the host

country. Foreign investments contribute in laying foundation for economic growth, increase

foreign currency, and domestic savings. The FDI enables the government to narrow the gap

between national savings and requirements of national saving. It positively influences the

country’s economy by reducing the intensity of unemployment because direct investments

usually secure job opportunities for the citizens of the host country. FDI are considered

among the most important means to attract the foreign funds through the investing companies,

which possess self-credit ability to finance different projects. Moreover, FDI also affects the

balance of payments in the host countries through negative and positive effect on the current

account. The increased inputs of national products represents positive effects of foreign direct

investments.

Acknowledgement

The author is very thankful to all the associated personnel in any reference that contributed in/for

the purpose of this research.

Conflict of Interest

This research holds no conflict of interest and is not funded through any source.

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