On Foreign Direct Investment from the ASEAN-8 Countries: A Panel
Data Estimation
INDRA SUHENDRA1*, NAVIK ISTIKOMAH2, CEP JANDI ANWAR3
1,3Department of Economics and Development Studies, Faculty of Economics and Business, University of
Sultan Ageng Tirtayasa, Banten, INDONESIA
2Department of Economics Education, Faculty of Economics and Business Education, Indonesia
University of Education, Bandung, INDONESIA
Abstract: - This paper examines how capital flight, loan interest rates, inflation, exchange rates and economic
growth influence foreign direct investment in the ASEAN-8 countries. We apply fixed effect estimation to panel
data for data belonging to eight countries from the period 1994 to 2018. The results show that capital flight and
economic growth have a positive and significant effect on foreign direct investment. An increase in capital flight,
capital retain from sources of funds which greater than the use of funds, has encouraged foreign direct investment
to increase. Furthermore, increased economic growth has stimulated foreign direct investment. We find that an
increase in loan interest rate (SIBOR), inflation and depreciation of the exchange rate triggers a significant decline
in foreign direct investment. This finding implies that capital retention from capital flight and economic growth are
the main factors that create an increase in foreign direct investment in the ASEAN-8 countries. Meanwhile, loan
interest rates (SIBOR), inflation and depreciation of the exchange rate are the risk factors that investors need to
consider when investing in those particular countries. This paper is useful for policy makers in the ASEAN-8
countries to consider these five variables, as the important factors that significantly influence foreign direct
investment in the ASEAN-8 countries.
Key-Words: Foreign Direct Investment; Loan Interest Rates; Inflation; Exchange Rate; Economic Growth; The
ASEAN-8 Countries; Panel Data Model; Fixed Effect Estimation
Received: April 26, 2021. Revised: December 13, 2021. Accepted: January 9, 2022. Published: January 10, 2022.
1. Introduction
The scarcity of domestic capital as a source of
development financing in developing countries has
encouraged the use of sources of funds originating
from abroad by these countries, whether by way of
foreign debt, foreign direct investment or portfolio
investment. The capital inflow from overseas to
domestic is an essential requirement for developing
countries to boost the economy.
Table 1. Average Ratio of Foreign Debt, Foreign Direct Investment,
Investment to GDP Ratio of ASEAN-8, 1994-2018
Negara
External Debt to
PDB Ratio
FDI to GDP Ratio
Portfolio Investment
to PDB Ratio
Indonesia
0.30
0.06
0.02
Malaysia
0.58
0.03
0.01
Thailand
0.35
0.02
0.01
Philippines
0.29
0.02
0.002
Vietnam
0.48
0.07
0.01
Myanmar
0.20
0.04
0.000087
Cambodia
0.54
0.13
0.0013
Laos
1.04
0.08
0.03
Source: Composed by the authors on data from the https://data.worldbank.org/. Data downloaded in January
2020
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Table 1 shows the average ratio sources of foreign
funds to GDP in the ASEAN-8 countries for the
1994 to 2018 period, consisting of foreign debt,
foreign direct investment and portfolio investment.
The ratio of foreign debt to GDP confirms the huge
use of foreign debt to GDP, which offers a red light
for the country of Laos (1.04), where the use of
foreign debt has exceeded 0.60 to GDP as a
maximum condition for debt sustainability.
Subsequently, there are yellow lights for Malaysia
(0.58), Cambodia (0.54), Vietnam (0.48), Thailand
(0.35) and Indonesia (0.30), for the reason that the
use of foreign debt has exceeded 0.30 to GDP.
Meanwhile, the use of foreign debt in the
Philippines (0.29) and Myanmar (0.2) remains green
because it is relatively safe with ratios which are
below 0.30.
However, if we note the average ratio of foreign
direct investment and portfolio investment to GDP,
it reveals the average value of the ratio of foreign
direct investment and portfolio investment to GDP
during the research period is below 0.15, with the
highest ratio achieved by Cambodia (0.13), followed
by Laos (0.08), Vietnam (0.07), Indonesia (0.06),
Myanmar (0.04), Malaysia (0.03), Thailand (0.02)
and the Philippines (0.02). Similarly, it can be seen
that the average ratio of the portfolio investment
achieved the highest average ratio at 0.03, whereas
the lowest average ratio, which was 0.000087, was
achieved by Myanmar.
The data above shows us that greater use of foreign
debt for development activities in the ASEAN-8
countries only causes a larger ratio of foreign debt to
GDP and may threaten the national economy.
Foreign debt has created several obligations, namely
the obligation to pay principal debt instalments and
interest on the debt. This obligation then becomes a
debt burden which becomes significant if the ability
to develop countries’ economies to generate foreign
export exchange is relatively low. This is
attributable to the low growth in exports.
Consequently, the higher a country's foreign debt,
the lower the ability to repay the debt.
Therefore, foreign debt is only required at a
reasonable level - additional foreign debt can be set
at a specific limit if it has a positive impact on
economic growth, so that debt payments do not
disrupt the stability of the domestic economy. The
level of accumulated foreign debt to GDP that is
above the tolerable limit can hinder a country's
economic growth. This limitation is termed ‘fiscal
sustainability’ and according to [1], is measured
using the ratio of external debt to GDP. [2] say that
fiscal sustainability is a valuable criterion for
evaluating whether fiscal policy is on the
appropriate long-term path. Fiscal sustainability is
challenged when the debt-to-GDP ratio is
overvalued and government revenue is insufficient
to continue to finance the costs of issuing new
government debt. [3], states that debt sustainability
is still tolerable if the debt-to-GDP ratio is not more
than 60%.
Concerning this serious problem that developing
countries will be confronted by in the form of
foreign debt payment as a consequence of the
addition of foreign debt, it is essential to continue to
encourage the use of other sources of foreign funds
in the ASEAN-8. These funds can be in the form of
foreign direct investment and portfolio investment,
where the ratio of foreign direct investment and
portfolio investment to GDP remained low during
this specific study.
Many macroeconomic variables influence foreign direct
investment as demonstrated by previous studies, such as
capital flight [4,5,6,7,8], loan interest rates [6,7,8,9],
inflation [5,10], exchange rates [6] and economic growth
[5,7,9]. Those variables are a major factor and can
significantly influence foreign direct investment. This
paper intends to obtain empirical evidence on what
macroeconomic variables have a significant effect on
foreign direct investment in the ASEAN-8 countries,
using panel data from the ASEAN-8 countries covering
the period 1994 to 2018.
2. Literature Review
In explaining the determinants of an investment
model, this study follows Keynes’ internal fund and
neo-classical theories, as well as Tobin’s q ratio. To
complement those theories, we refer to the previous
empirical research which relates to our study. Based
on the marginal efficiency of capital (MEC)
concept, [11], explained investment demand.
According to [11], demand for investment is
determined by the size of the present value of the
expected net income for additional capital
expenditures at the current cost of capital. Thus,
based on this theory, investment depends on the
discount rate which states the flow of gains expected
in the future at the present cost of additional capital.
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The greater the present value of the expected net
gain on additional capital expenditures compared to
the current level of costs, the greater the demand for
investment. Based on this particular theory,
investment demand (FDIt), depends on the rate of
return (R), the real interest rate (i) and the cost of
capital incurred (Ck) or is formulated in the form of
a function to be:
FDIt = f (R, INT, Ck) (1)
where R is the return, INT is the interest rate and Ck
is the costs incurred to obtain capital stock.
Based on internal funds theory of investment, the
demand for an investment is determined and
depends on the level of return [12]. The rate of
profit is the level of future expected profit which is
signified by the difference between real interest rate
and expected future risk. However, several prior
studies employed inflation rate as a proxy for risk.
For foreign direct investors, not only interest and
inflation but also changes in exchange rates are a
factor that must be considered to be a risk. A change
in exchange rates (depreciation and appreciation)
affects the number of investments. Thus, according
to internal funds theory, the demand for investment
(FDIt), is a function of the interest rate (INT),
inflation (INF) and the exchange rate (ER).
Therefore, the model is:
FDIt = f (INT, INF, ER) (2)
According to neo-classical theory, a stock of capital
in a firm is determined by the output and the prices
of capital relative to output price. The price of
capital depends on capital goods, interest rate and
the tax treatment of a firm’s income. Thus, it can be
written as the mathematical function:
FDIt = f (GRT, k, INT, Tax) (3)
where GRT is the change in output, k is capital
goods, i is real interest rate and Tax is income tax.
This study considers Tobin's q theory as a factor that
influences investment. According to this theory,
investment is highly dependent on the market value
of capital compared to replacement costs [13]. If the
market value of capital compared to replacement
costs is greater than 1 (q> 1), firms will increase
their market value by providing more capital.
Conversely, if q <1 signifies the market value of
capital less than the replacement cost. In such
circumstances, firms will not increase their capital.
Generally, Tobin’s q theory is similar to Keynes’
theory, which confirms that company investment is
highly dependent on the level of profit and costs.
However, in Tobin's q theory, level of profit is the
current market value, although in Keynes’ theory,
the profit level is the present value of future profits.
Likewise in terms of costs, in Tobin’s q theory, the
cost is the replacement cost, while in Keynes’
theory, the cost is the additional cost of capital
goods. According to Tobin’s q theory, the desired
investment or stock of capital (It) is influenced by
the market price (Pm) and the cost of replacing
capital goods (CR).
FDIt = f (Pm, CR) (4)
where Pm is the market price of capital stock and CR
is the replacement cost of capital stock. By
combining equations (1) to (4), we have:
FDIt = f (R, INT, Ck, INF, ER, GRT, k,
Tax, Pm, CR) (5)
where R is the expected rate of return, INT is the
interest rate, CK and CR are the costs incurred to
obtain capital stock, INF is inflation, ER is the
exchange rate, GRT is the change in output, k is
availability of capital goods, Tax is income tax and
Pm is the market price of capital stock. However,
due to the availability and limitations with respect to
data for each country, this paper uses the interest
rate, inflation, exchange rate and economic growth
as the estimator variables in determining foreign
direct investment. Based on that, the formulation of
the equation is:
FDIt = f (INT, INF, ER, GRT) (6)
Besides the variables in equation (6), another
independent factor that cannot be ignored to
examine its correlation with foreign direct
investment is the capital flight variable. In this
study, we use capital flight proposed by the World
Bank [14], which estimates the capital flight by
measuring the difference between the residual of
source of funds and use of funds. Sources of funds
include all net official inflows (increases in public
sector net external debt and net foreign direct
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investment flows). However, the use of funds
includes current account deficits and changes in
foreign exchange reserves. Outward capital flight
occurs when the source of funds is higher than the
use of funds and vice versa. The equation for this
approach can be written as:
CF = (∆ED + ∆FDI) – (CA + ∆OR) (7)
where CF is capital flight, DED is change in
external debt, ∆FDI is net private direct investment,
CA is current account (surplus/deficit) and ∆OR is
change in foreign exchange reserve. The use of the
residual approach to measuring capital flight in the
ASEAN-8 countries refers to the empirical study
conducted by [15,16,17,18,19] as well as [20]. We
add the capital flight variable into formula (6), then
the research model is obtained:
FDIt = f (CF, INT, INF, ER, GRT) (8)
Prior empirical studies regarding the positive impact
of capital flight on foreign direct investment, such as
[4,6], who state that capital flight has a positive
effect on foreign direct investment. Meanwhile, the
opposite results are shown by [5,7], as well as [8],
who state that capital flight has a negative impact on
foreign direct investment.
A further macroeconomic variable that determines
foreign direct investment is interest rate. A decrease
in loan interest rate has an effect on lowering credit
interest but then encourages greater investment.
Demand for capital depends on the loan interest rate
which measures the cost of the funds to finance
foreign direct investment [21]. To establish foreign
direct investment that is profitable, the outcome
(revenue from an increase in the future production
of goods and services) must be higher than its costs
(payments for loanable funds). However, if the loan
interest rate increases, it creates lower profitable
foreign direct investment; thus, demand for
investment goods decreases. The investment
function relates to the amount of investment and the
interest rate for the reason that the interest rate is the
cost of funds [12]. Investors have willing to pay off
the loan interest rate for investment if they expect to
obtain a greater income from their investment than it
costs to fund. This profit is the main reason that
investors are attracted to boosting foreign direct
investment. One possible reason to make investment
profitable is a low interest rate. Previous studies
confirm the negative effect of interest on
investment, such as [6,7,8,9], which assert that
interest rate has a negative effect on foreign direct
investment.
Empirically, inflation and exchange rate have a
negative effect on foreign direct investment. The
effect of inflation on foreign direct investment has
been shown in the work of [5,10]. They show
empirical evidence of the negative and significant
influence of inflation on foreign direct investment.
Conversely, the result obtained by [6], establishes
the negative effect of the exchange rate on foreign
direct investment. This finding confirms that higher
inflation and depreciation of the exchange rate
results in a drop in foreign direct investment.
Theoretically, there is a relationship between
national output and foreign direct investment.
Economic growth reflects the market size of a
country, which demonstrates higher potential
economic and aggregate demand. Thus, it is a good
signal for foreign investors to invest in a domestic
country and as a result, increases foreign direct
investment. Conversely, a decrease in economic
growth creates a decline in foreign direct
investment. This is in line with the empirical study
conducted by [5,9], who conclude that economic
growth has a positive and significant effect on
foreign direct investment. However, in the research
undertaken by [7], the effect of economic growth on
foreign direct investment illustrates the opposite.
3. Data and Methodology
3.1 Data
This study uses panel data for the ASEAN-8
countries with annual data from 1994 to 2018. All
research data uses secondary data obtained online
from official World Bank publications.
Foreign direct investment is the total value of the
realisation of foreign direct investment (FDI) in a
million USD in the ASEAN-8 countries. The value
of capital flight is calculated using the residual
approach used by the World Bank [14], which is the
amount of residual value that indicates the net
difference from funding sources in relation to the
use of funds. Sources of funds include all net
official inflows (increase in net public sector
external debt) and net foreign direct investment
flows. Fund users include current account deficits
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and additional reserves. Outward capital flight
occurs when the source of funds exceeds the use of
funds and vice versa for the flight of capital in
(Inward Capital Flight). Interest rate (INT) is the
reference interest rate for international loans which
will be proxied using SIBOR (Singapore Inter-Bank
Offered Rate). The use of SIBOR reference lending
rates is related to the majority of foreign direct
investors in the ASEAN-8 from Singapore, whose
investment funding uses bank funds.
Inflation is the increase in price in the ASEAN-8
countries, calculated based on the CPI. The
exchange rate is the amount of the nominal
exchange rate in the ASEAN-8 countries against the
US dollar. Economic growth is the increase in
economic growth value in the current year in the
ASEAN-8 countries, which is measured based on
constant prices in 2010.
3.2 Econometrics Methodology
The econometric methodology used in our model in
equation (8), is a multiple regression equation model
using panel data, which is a combination of time
series and cross-section data. To obtain the best
panel model, the common effect model, fixed-effect
model and random effect model will be tested, by
way of the Chow and Hausman tests. In our research
model equation, we will also test classical
assumptions and undertake other essential tests.
To examine the effect of macroeconomic variables
on FDI, we use a panel data with fixed effect
estimation. Additionally, classical assumption and
other essential tests will be conducted on the model.
Consider the following standard panel regression:
(9)
where i is country cross-section, t represents time.
is dependent variable, and is matrix of
explanatory variables. is error disturbance, with:
(10)
where µi denotes the unobservable country-specific
effect and νit represents the remainder disturbance.
The model does not account for country-specific
effects such as cultural, political, and institutional
elements that change over time [22]. [23]
demonstrates that these unobservable country-
specific effects can be accounted for in a one-way
error component model. The following is the
equation for the fixed effect:
(11)
For each country observation i, averaging equation
(12)
Then subtracting Equation (12) from Equation (11)
gives:
(13)
Note that the unobservable country-specific effect,
µi, has disappeared. The transformation process in
Equation (13) is known by within transformation.
In this study, we use various macroeconomics
variables that have a significant effect of foreign
direct investment as formula (8), both theoretically
and empirically. The most relevant empirical studies
include [4,5,6,7,8,9].
[4] investigates the correlation between capital
outflow and direct investment in Russia and China.
The estimation results conclude that capital flight
has a positive correlation and significant impact on
direct investment in Russia, whereas in China it
shows the opposite. [5], uses the ratio variable for
capital flight to GDP, economic growth, domestic
investment the previous year, inflation and private
credit to examine their effects on direct investment
in 15 countries in the former French colonies in
Africa from 1970 to 2005. The results indicate that
except for the economic growth variable, all
independent variables have a significant effect on
the direct investment variables. Subsequently, the
variable of capital flight ratio to GDP and inflation
has a negative influence on the direct investment
variable. Meanwhile, the economic growth variable
is direct investment from the previous year and
private credit that has a positive influence on the
direct investment variable.
[6], applies the variables for capital flight, interest
rates and exchange rates to study their effects on
investment in Nigeria from 1970 - 2006. The results
showed that there is a positive but not significant
effect of the capital flight variable on investment,
while interest rates and exchange rates have a
negative effect on investment. In their study, [7],
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estimate the effect of capital flight, government
spending, interest rates, economic growth the
previous year, exchange rate and terms of trade on
investment in the Caribbean country of Trinidad and
Tobago, for the period 1971-2008. The results
revealed that the capital flight variables and
economic growth in the previous year has a negative
and significant effect on investment, although
government spending and the economic growth
variable has a positive and significant influence on
investment. [9], applies investment variables from
previous years, capital flight, economic growth,
private credit, real interest rate, terms of trade and
foreign investment debt in 21 countries in Asia,
Africa and Latin America covering the period 1975
- 2000. The research results demonstrated the
following: (1) except for the interest rate variable
and foreign debt, all other independent variables
have a significant effect on investment, (2) capital
flight, real interest rates and terms of trade have a
negative influence on investment and (3) the
previous year's investment variable, economic
growth, private credit and foreign debt has a positive
influence on investment.
Furthermore, regarding the research conducted by
[8], on the impact of capital flight, interest rates,
investment credit, terms of trade and foreign debt in
relation to private sector investment in Kenya for
the period 1970 to 2012, the results showed that (1)
except for the terms of trade and foreign debt
variables, all variables have a significant effect in
connection with private investment, (2) capital flight
and interest rate variables have a direct negative
influence on private investment, and (3) investment
credit variables, terms of trade and debt abroad has a
direct negative influence on private investment.
In this study, we use various macroeconomic
variables that are thought to have an influence on
foreign direct investment as the empirical results
above show. Hence, the research model is described
as follows:
(14)
In equation (14), i = 1, 2, ..., N for countries cross-
section, t = 1, 2, ..., T for time series, FDI represents
the realisation of foreign direct investment, CF
describes capital flight, INT shows the loan interest
rate, INF is the inflation rate, ER is the exchange
rate, GRT is economic growth, meanwhile is the
country specification effect.
4. Empirical Results
4.1 Descriptive Statistics
Table 2 shows the various research data from the
variables that will be used in this research during the
twenty-five-year study period. With respect to
capital flight data, it can be seen that the minimum
value is -50,188.08 and the highest is 80,315.46.
This shows that there was capital flight out of USD
80,315.46 million and capital flight of USD
50,188.08 million that occurred in Indonesia in 2018
as a result of the increasing growth in debt from the
public sector. However, capital inflows occurred in
Thailand in 2016 amounting to USD 50,188.08
million. Furthermore, the data on loan interest rates
using the SIBOR reference rate indicates a
minimum value of 0.58% occurred during the 2014-
2018 period, whilst a maximum value of 6.87% took
place in 2000. This situation confirms that the loan
interest rate is at a low value for the last year and is
profitable for investors whose funding comes from
international banks in the ASEAN.
Table 2. Descriptive Statistics
Variable
Abbreviation
Mean
Std Dev.
Min.
Max.
Capital Flight
CF
3184.994
18042.82
-50188.08
80315.46
Loan Interest Rate
INT
2.73
1.97
0.58
6.87
Inflation
INF
8.14
13.49
-1.71
125.27
Exchange Rate
ER
4661.28
6058.14
2.50
22602.05
Economic Growth
GRT
6.14
3.27
-13.13
13.84
Foreign Direct Investment
FDI
4149.925
5181.558
-4550.360
25120.73
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A further fact relates to the inflation variable, where,
in general, the average inflation rate in all ASEAN-8
countries is also relatively large at 8.14%. The
interesting point pertaining to this inflation data is
that there is a maximum inflation value of 125.27%,
which occurred in Laos in 1999. This relates to
Laos, which has only been a member of the ASEAN
for two years and where initially, joining as a
member of ASEAN was limited to the distribution
of goods and logistics, and where some of the
population’s basic needs were met by the
surrounding countries. However, at present, with the
development of the country's economy, their basic
needs have been met by logistics distribution in the
country and by the ASEAN countries.
Furthermore, the domestic currency exchange rate
against the US dollar demonstrates the purchasing
power of the ASEAN-8 currencies against one US
dollar, where the strongest purchasing power, 2.50
Malaysian Ringgit against 1 US dollar occurred in
1995. Meanwhile, regarding the purchasing power
of currency, the weakest amount was 22602.25
Vietnamese Dong against 1 US dollar in 2018.
Regarding economic growth data, it can be seen that
even though the average economic growth achieved
in the ASEAN-8 countries is relatively high at
6.14%, there are countries that are able to achieve
economic growth that is relatively high, a maximum
of 13.84% (Myanmar in 2003) and a country with
minimum economic growth of -13.13, namely
Indonesia in 1998, when the financial and monetary
crisis occurred. Nevertheless, data on foreign debt
growth shows that the average growth in the
ASEAN-8 is 6.96%. The highest growth in relation
to foreign debt occurred in Thailand in 1995, while
the lowest growth in debt was in Vietnam in 2000.
4.2 Result of the Chow and Hausman Tests
Table 3 reveals the results of the Chow and
Hausman tests for equation (4). The Chow test
reveals the probability of Cross-section Chi-Square
< alpha (5%) or 0.0000 <0.05, whereas the
Hausman test demonstrates the probability of Cross-
section Random < alpha (5%) or 0.0011 <0.05.
Based on those tests, it can be concluded that the
most appropriate panel data regression estimation
for this study is a fixed effects model (FEM).
Table 3. Results of Chow and Hausman Tests
Num.
Testing
Value
Conclusion
1.
Chow test
Cross-section Chi-square
47.192
fixed effect model (FEM)
Prob.
0,0000
2.
Hausman test
Cross-section random
22.2212
fixed effect model (FEM)
Prob.
0.0011
4.3 Result of Classical Assumption and
Normality Tests
It is necessary to test the classical assumptions
(multicollinearity, heteroscedasticity and
autocorrelation) and the normality tests to determine
the validity of the research data. Table 4 presents the
correlation matrix to detect the presence of
multicollinearity problems. According to [24]
Asteriou and Hall (2015), the multicollinearity
problem exists if there is a correlation between the
independent variables higher than 0.80. Table 4
shows the correlation between independent variables
with less than 0.80. Thus, it can be concluded that
there is no multicollinearity problem in relation to
our model.
Table 4. The Result of Multicollinearity Test
DINT
INF
LNER
GRT
GDEBT
CF
1.0000
-0.2424
0.0035
0.2468
-0.0081
INT
-0.2424
1.0000
0.2711
-0.0831
0.0814
INF
0.0035
0.2711
1.0000
0.0451
0.0029
ER
0.2468
-0.0831
0.0451
1.0000
0.0261
GRT
-0.0081
0.0814
0.0029
0.0261
1.0000
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Table 5. The Results of the Heteroscedasticity, Autocorrelation and Normality Tests
Num.
Testing
Value
Conclusion
1.
Heteroscedasticity (White test)
n-observed
200
<
no heteroscedasticity
r-squared
0.1063
Chi Square count
21.2720
Chi Square table (20; 0.05)
31.4104
2.
Autocorrelation (Durbin-Watson test)
Durbin-Watson count
1.9464
DU < 1.9464 < 4 - DU
no autocorrelation
Nilai DL
1.7180
Nilai DU
1.8200
Nilai 4-DU
2.1800
Nilai 4-DL
2.2282
3.
Normality (Jarque-Berra test)
Jarque-Berra
4.7472
normally distributed
Prob.
0.0931
Table 5 presents the results of the White test to
detect the presence of heteroscedasticity problems.
The results of the Durbin-Watson test to detect the
presence of autocorrelation problems and the Jarque
Berra test to see whether or not the residuals of the
data are normally distributed, conclude that data are
free of heteroscedasticity and autocorrelation
problems and that the residual of the data is
normally distributed
4.4 Result of Fixed Effect Model
Table 6 reveals the result of panel data estimation
with the fixed effect model. Capital flight and
economic growth have a positive and significant
effect on foreign direct investment at the 1 percent
level. Loan interest rates, inflation and exchange
rates have a negative and significant effect on
foreign direct investment with different significance
levels. The determination coefficient (r-square) and
the adjusted coefficient of determination (adjusted r-
square) are 0.7645 and 0.7481, respectively. R-
squared shows the independent variables to explain
the variation in the change in foreign direct
investment; 76.45% or 74.81% after adjustment,
while the remaining 23.55% or 25.19% after
adjustment is explained by variations in other
variables which are not included in our model in this
particular study. The F-statistic for our model is
46.46. It is significant at the 1 percent level. This
result implies that all independent variables have a
significant effect on the dependent variable at the 1
percent level.
Table 6. Fixed Effect Estimation
Variable
Estimate
t-Statistics
Prob.
CF
0.123989
11.9160
0.0000***
INT
-394.0158
-4.3411
0.0000***
INF
-7.609819
-2.0881
0.0381**
ER
-110.9557
-2.5602
0.0113**
GRT
384.8721
6.2560
0.0000***
Constant
6695.265
11.4512
0.0000***
R2
0.7645
Adj. R2
0.7481
F-statistic
46.4663
0.0000***
Durbin-Watson stat
2.0357
Notes:
1. The dependent variable is capital flight.
2. The symbols *, **, *** denote statistical significance at the 10%, 5% and 1%.
.
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5. Discussion
The estimation results of the effect of capital flight,
interest rates, inflation, exchange rates and
economic growth on foreign direct investment are
consistent with the theory. The magnitude of the R2
is 0.7645. This result indicates that the variation in
the change in the dependent variable (FDI) can be
explained by the variation in the change in the
independent variable of approximately 76.45%.
Thus, the ability of the independent variable in
explaining the dependent variable is 76.45%,
whereas the remaining 24.55% is explained by other
variables that are not included in the model.
First, we will consider the effect of capital flight on
foreign direct investment. We find that capital flight
has a positive and significant effect on foreign direct
investment with a coefficient of 0.1239. This result
implies that an increase in the residual value
(outward capital flight) of capital flight indicates an
additional source of outside funds of 1 million USD
that encourages an increase in foreign direct
investment in the ASEAN-8 by 0,1239 million
USD. This result is in agreement with the empirical
studies performed by [4,6], who show empirical
evidence of the positive and significant effect of
capital flight on foreign direct investment. However,
our result contrasts with the research of [5,7,8], who
find the opposite as regards the effect of capital
flight on foreign direct investment.
The implication of this finding is that an increase in
capital outflow (outward capital flight) has a
positive and significant effect on influencing foreign
direct investment in the ASEAN-8 countries. The
positive direction of capital flight to foreign direct
investment refer to the explanation given in the
study conducted by [4]. First, for developing
countries which have a limitation in funding
sources, the role of capital inflow in the form of
foreign debt and foreign direct investment are the
main source of finance for the development of
countries, seeing that the sources of internal finance
in the form of taxes and savings are limited. The
results of this study have reaffirmed the fact that the
greater the residual value of capital flight, the
greater the foreign direct investment entering the
ASEAN-8 countries. Second, the greater the
residual of capital flight indicates the greater
confidence of foreign investors to invest in the
domestic economy, thus encouraging higher foreign
direct investment. Third, the high confidence level
of foreign investors in relation to the repayment of
foreign debt and interest by the government or
private sector besides the transfer of profits abroad
from direct foreign investment activities by foreign
investors without any restrictions or obstacles from
the policymakers’ regulations. This implies that the
large residual of capital flight positively indicates a
higher amount of foreign direct investment.
Furthermore, the results of this study establish that
loan interest rates have a negative effect on foreign
direct investment. The loan interest rate is the main
factor determining the rate of foreign direct
investment. In this study, we refer to the SIBOR as a
loan interest rate given that SIBOR is connected to
the nature of foreign direct investment which comes
from the international banks. The reference for
interest rate (SIBOR, LIBOR), is generally used as a
reference in determining loan interest rates for
international funding since it is the basic function of
investment which relates the amount of investment
to a certain investment interest rate because the
interest rate is the cost of borrowing funds [12]
(Mankiw, 2012). The negative coefficient of loan
interest rate on foreign direct investment is
consistent with the results of previous empirical
studies, such as [6,7,8,9], who state that the loan
interest rate has a negative effect on foreign direct
investment. Concerning foreign investors whose
funding is derived from financial institutions,
foreign direct investment activities depend on the
rate of loan interest rate as it is a component of the
cost of funds used to finance foreign direct
investment. Foreign investors are basically willing
to pay loan interest for foreign direct investment
activities when the funds can be used for activities
which are expected to generate greater income than
the amount invested. This excess revenue over
expenditure (profit) is a source for investors to pay
interest on a loan, where this condition occurs when
the cost of funds (interest) in the market is relatively
cheap.
The next variable is inflation. Our result shows that
inflation rate has a negative and significant effect on
foreign direct investment. The result of this study is
in agreement with the empirical results obtained by
[5], who asserts that the inflation variable has a
negative effect on foreign direct investment. This
empirical finding confirms that higher inflation
results in a decline in foreign direct investment in
the ASEAN-8 countries. Thus, inflation is a factor
that should be considered by investors who wish to
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invest funds in the ASEAN-8 countries. According
to [25], the reasons for the negative effect of
inflation on investment are first that inflation causes
higher bank interest rates, both savings and credit
interest rate. A higher interest rate increases the cost
of funds; thus, funds are more expensive. Hence, it
affects the real sector and reduce investors’ interest
in utilising funds from the banking sector due to the
high cost of capital, particularly for those whose
funding sector depends on bank loans. Second,
inflation reduces the value of national savings and
the investor tends to choose to invest their funds in
good assets. Third, inflation results in a decline in
the real value of public wealth in the form of cash.
In other words, the value of money becomes smaller
because the commodity price per unit increases
nominally. In contrast, concerning those who have
considerable wealth in the form of fixed assets or
non-liquid assets; those assets actually benefit from
the increase in prices. Thus, inflation leads to a
greater income gap. Fourth, inflation hampers
economic growth. Specifically, a production slump
occurs, both for export-orientated products and
products for the domestic market. Fifth, in terms of
foreign exchange rate, the domestic currency
depreciates against foreign currencies which in turn
causes other problems, for instance an increase in
government obligations to foreign creditors.
The following result pertaining to this study is the
negative effect of exchange rate on foreign direct
investment. This result implies that an increase in
the exchange rate of the domestic currency
(depreciation) against the US dollar causes a
decrease in foreign direct investment. Conversely, a
decrease in the domestic currency exchange rate
(appreciation) generates an increase in foreign direct
investment. Several previous empirical studies
which conclude that the exchange rate has a
negative effect on foreign direct investment include
[6,7]. According to [26], the occurrence of
depreciation or devaluation tends to affect the trade
exchange rate (terms of trade). A depreciation of the
exchange rate stimulates export production because
export prices fall in foreign currency so that the
export volume increases. This occurs if the raw
materials and supporting materials for export
products produced domestically. Meanwhile, if the
raw materials and supporting materials come from
abroad, the depreciation in the domestic exchange
rate causes a decrease in foreign direct investment,
because depreciation tends to push import prices up.
The last finding as regards this study is the positive
and significant effect of economic growth on foreign
direct investment. This result indicates that an
increase in economic growth produces an increase in
foreign direct investment. This finding is in line
with economic theory where economic growth is
considered positively by foreign investors prior to
making foreign direct investments in the ASEAN-8
countries. The result of this study supports the
empirical studies performed by [5,9], which
conclude that economic growth has a positive and
significant effect on foreign direct investment.
6. Conclusion and Recommendations
This study reveals empirical evidence that capital flight
and economic growth have a positive and significant
effect on foreign direct investment. This implies that an
increase in capital flight and economic growth has also
encouraged foreign direct investment to increase.
Meanwhile, loan interest rates, inflation and exchange
rates have a negative and significant effect on foreign
direct investment. These results signify that an increase in
the SIBOR loan interest rate, the increase in the inflation
rate and the depreciation of the domestic currency trigger
a decline in foreign direct investment. These results have
been consistent and support the results of previous
studies.
Our findings produce several recommendations. First, it
is necessary to optimise the residual value of capital flight
in the form of capital retained for productive and valuable
things, such as for job creation, in order to reduce
unemployment, poverty and increase people’s purchasing
power. Second, this study encourages the Central Bank to
reduce the interest rate, which is followed by a reduction
in the banking sector, as well as encouraging the banking
system to play a role as an intermediary so that savings
increase. Hence, this will create a wider financing scheme
with lower costs and moreover, makes it inexpensive to
support foreign direct investment activities in the
ASEAN-8 countries. Third, we encourage maintaining
inflation at the targeted rate via a mix of monetary policy,
fiscal policy and real policy. Fourth, maintaining and
encouraging the domestic exchange rate to be stable,
whilst efforts to strengthen the exchange rate in the long-
term must be continued. Fifth, strengthening the
prospects of the national economy is always positive with
the aim of encouraging the creation of national economic
growth that provides various profit opportunities for
business activities and attracts domestic and foreign
investors.
Our work can be extended for a future empirical study
such as adding another region and compare the result
with this study.
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