The Effect of Fdi on Stock Market Development

The effect of FDI on Stock Market Development

Mariam Ahmed Malik

BBA C

Institute of Management Sciences

Peshawar, Pakistan

2017

Introduction:

Stock Market is one of the fundamental element of any financial system. Stock market also predicts the future growth and development of economy. Well-Developed financial markets are very important in order to attract investment in country, which will give confidence to investors that profit-generating projects are being carried in the country. For assuring, the growth in economy strong financial market is necessary. Pakistan Stock Exchange is the only working stock exchange in Pakistan. Recently in 2017, Government of Pakistan has merged Karachi Stock Exchange (KSE), Lahore Stock Exchange (LSE) and Islamabad Stock Exchange (ISE) into one exchange that is Pakistan Stock Exchange (PSX).

One of the leading source of investment for a developing country is foreign direct investment. It makes the flow of technologies, managerial skills and human capital between developing country and developed countries. Study conducted in case of Pakistan revealed that there is a strong positive relationship between foreign direct investment, Exchange rate and domestic savings in emerging and developing stock markets of Pakistan. Different literature shows different findings about FDI promoting economic growth. Adhikary, 2009; Borensztein, 1998; Ekanayake & Ledgerwood 2010; Atroyee & Hendrik 2004 in there researches declared through empirical evidences that Foreign direct investment promotes economic growth. Agarwal (2001) in his research found that stock market development in a country is correlated with investments and with increased investments in country, the economy will grow. Foreign direct Investment in host country facilitates them in achieving economies of scale (Adhikary, 2009). Steady macro environment factors in a country lead to improvement in stock market development.

Exchange rate is very important to discuss when it comes to Foreign Direct Investment because foreign investor faces the exchange rate risk. Sound exchange rate system is very necessary in order to attract investment. When the exchange rate of host country starts to decrease due to various economic and political factors prevailing in the country the profitability of foreign investor decreases. When we study Foreign Direct Investment in Pakistan Exchange rate is probably the most important factor. It is due to exchange rate risk that foreign direct investment is decreasing in Pakistan over the past years. This study will find the potential effect of foreign direct investment (FDI) on Stock Market Development keeping in view Exchange Rate as it is one of the major risk involved in FDI. Data will be collected for 40 years 1972-2012. Reason for conducting this study is that no such study has yet been conducted for this period.