Is stock market sensitive to foreign capital inflows and economic growth?. Evidence from Pakistan
| DOI | https://doi.org/10.1108/JCEFTS-03-2015-0012 |
| Pages | 142-164 |
| Date | 05 October 2015 |
| Published date | 05 October 2015 |
| Author | Syed Ali Raza,Syed Tehseen Jawaid,Sahar Afshan,Mohd Zaini Abd Karim |
| Subject Matter | Economics,International economics |
Is stock market sensitive to
foreign capital inows and
economic growth?
Evidence from Pakistan
Syed Ali Raza
Business Administration Department, IQRA University, Karachi, Pakistan
Syed Tehseen Jawaid
Department of Economics, SZAB University of Law, Karachi, Pakistan
Sahar Afshan
Business Administration Department, IQRA University, Karachi,
Pakistan, and
Mohd Zaini Abd Karim
Othman Yeop Abdullah Graduate School of Business,
Universiti Utara Malaysia, Kedah Darul Aman, Malaysia
Abstract
Purpose – The purpose of this study is to investigate the impact of foreign capital inows and
economic growth on stock market capitalization in Pakistan by using the annual time series data from
the period of 1976 to 2011.
Design/methodology/approach – The autoregressive distributed lag bound testing cointegration
approach, the error correction model and the rolling window estimation procedures have been
performed to analyze the long run, short run and behavior of coefcients, respectively.
Findings – Results indicate that foreign direct investment (FDI), workers’ remittances and economic
growth have signicant positive relationship with the stock market capitalization in long run as well as
in short run. Results of the dynamic ordinary least square and the fully modied ordinary least square
suggest that the initial results of long-run coefcients are robust. Results of variance decomposition test
show the bidirectional causal relationship of FDI and economic growth with stock market
capitalization. However, unidirectional causal relationship is found in between workers’ remittances
and stock market capitalization.
Practical implications – It is suggested that in Pakistan, investors can make their investment
decisions through keeping an eye on the direction of the considered foreign capital inows and economic
growth.
Originality/value – This paper makes a unique contribution to the literature with reference to
Pakistan, being a pioneering attempt to investigate the effects of foreign capital inows and economic
growth on stock market by using long time series data and applying more rigorous techniques.
Keywords Remittances, Economic growth, Foreign direct investment, Stock market capitalization
Paper type Research paper
JEL classication – F24, F21, F43, G20
The current issue and full text archive of this journal is available on Emerald Insight at:
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JCEFTS
8,3
142
Journalof Chinese Economic and
ForeignTrade Studies
Vol.8 No. 3, 2015
pp.142-164
©Emerald Group Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-03-2015-0012
1. Introduction
In recent years, strong nancial systems have been recognized as main determinants of
economic stability and development. Efcient nancial systems contribute in
deployment of monetary resources by initiating long-term investment and enhancing
monetary intermediation. Stock market is considered as an integral part of the country’s
nancial system. Development of stock markets and nancial systems are interrelated
through numerous channels with economic conditions of a country. Improved
functioning and sound performance of nancial markets provide greater yields to the
saver through utilizing prociencies and economy of scales.
Financial development advances economic functions by supporting allocation of
investment in an organized way and setting pool of funds available to investors by
providing the possibility of huge investment projects. The liquidated nature of stock
market also protects the savers against the stress of losing control over their savings for
long period of time and builds the condence of the investor[1]. A well-functioning stock
market offers transmission of information and reduced transaction cost which enable
the investors to allocate their investment in protable projects that can provide fruitful
channeling of their saving to investment[2].
With the rising importance of stock market and international integration, numerous
theoretical and empirical researches have specied that economic growth is a genuine
reection of stock market development. Empirical results have indicated the signicant
positive impact of stock market development on economic growth of diverse
economies[3]. Modigliani (1971) claimed that rise in the stock prices leads to increase
individual wealth holdings that simultaneously results in higher consumption or
savings. Duca (2007) also argues that the countries doing well in terms of economic
growth have better domestic stock market performance. Rapid or sustainable economic
growth builds the condence of domestic or international investors. Increased
investment activities ultimately lead to the progress the overall economy.
Capital inows are mostly found to be linked with stock market performance.
Foreign direct investment (FDI) and workers’ remittances have proved to be an
important source of capital inow in developing countries. FDI might contribute both
positively and negatively in the development of stock market. It is found that greater
focus and dependence on FDI may discourage the local industry. Entrance of foreign
companies in the imperfect competitive markets may lead to reduce market share of
domestic producers. Capabilities of economies of scale also suffer in domestic producers
because of loss of market share and result in negative impact on productivity[4]. More of
the research shows that FDI might boost stock market performance, and empirical
evidence tends to provide some support to this nding by showing positive relationship
between market capitalization and FDI[5]. In most of the developing countries, FDI
contributes by fullling the gaps of technology, capital formation, human capital
formation, managerial skills and provide more competitive environment for domestic
producers[6].
Workers’ remittances have also become a central source of income for the economic
growth of countries. Literature seems to agree that remittances encourage development
of the nancial sector. Inow of remittance in the economy assist nancial sector by
enhancing the level of disposable income especially in emerging countries. Workers’
remittances offer growth in external source of income and contribute to raise minimum
wages level in developing countries. This instigates the trend of private savings, which
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Foreign
capital inows
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