THE RELEVANCE OF EXTERNAL DEBT THRESHOLD IN THE RELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENTAND ECONOMIC GROWTH: A CASE OF PAKISTAN

Abstract

In this thesis we intend to assess the role of external debt as a factor constraining the gains in economic growth to be achieved from the foreign direct investment (FDI) in Pakistan. In this regard, we use a model to implement a mechanism to allow for the influence of external debt in the transmission of positive externalities that are being generated via foreign direct investment. In this context, we use threshold regressions to assess whether there exists a debt contingency effect that offsets the positive effect of foreign direct investment on country’s economic growth. In this regard, using the annual data for Pakistan over the period of 1990-2018, dependent on the external debt constraint the empirical estimates are used to examine the proposition that “attainment of growth via foreign direct investment is subject to the external debt constraint”. Moreover, the study also examines that beyond a certain threshold benchmark, higher the indebtedness lower are the desired growth benefits from FDI. Finally, we examine whether financial development in the country is a source of mitigating the damaging impact of high levels of external debt on the FDI-growth nexus. Our empirical findings back the hypothesis that external debt constraint has a strong influence over the economic growth based on FDI. We specifically show that Pakistan fails to reap the growth benefits from FDI when its external indebtedness is beyond a certain threshold level. We thus conclude that the negative influence of high external indebtedness on the relationship between FDI and growth can be offset by increasing financial development in the country.