Assessing the Catalytic Role of Foreign Direct Investment in Sri Lanka: 1977- 2020

Abstract

Foreign Direct Investment (FDI) is an important factor in promoting the economic growth of a country. It transfers advanced-technology from developed to developing countries, stimulates domestic investment, and develops new skills and techniques. This study investigates whether FDI induces economic growth in Sri Lanka using timeseries data over the study period of 1977 to 2020. In this study the Autoregressive Distributed Lag (ARDL) Bounds cointegration technique was employed as an analytical tool. Despite all variables being in first difference (I(1)), the ARDL approach was selected given the limited sample size and the focus on short- and long-run dynamics. The ARDL Bounds cointegration technique confirms that there is a long-run relationship between the variables used in this study. The estimated coefficient of FDI reveals that Foreign Direct Investment induces economic growth in Sri Lanka. Further, the estimated coefficient of error correction term illustrates that the response variable of economic growth moves towards the long-run equilibrium path with correcting 22 percent of error every year. Therefore, government should create a supportive environment for FDI, while maximizing its benefits and mitigating any potential negative impacts.