A major source of investment inflow for a developing country is foreign direct investment (FDI) that provides a passage for technology, managerial skills and human capital for host country ( Chen, 1992 ). Raza
FDI is a cross-border investment in which a resident in one economy acquires a lasting interest in an enterprise in another economy. Usually, atleast 10 percent ownership in a foreign enterprise is necessary for being called a foreign direct investor otherwise it is portfolio investor ( OECD, 2008 ). FDI and ER have a significant and direct impact on stock market performance in South Asian countries (Aurangzeb, 2012). FDI can be linked positively with economic growth in home countries but developed countries do not show this trend. Panel data study from emerging economies showed positive relationship between FDI and stock market development but for sectors the relationship was found to be uncertain ( Soumaré and Tchana, 2011 ). The relationship between FDI and fixed capital is found to be positive ( Krkoska, 2001 ; Chousa
Korgaonkar (2012) argued that the development of the financial system of the host country is vital and a prerequisite for FDI to have a positive impact on economic growth. Using ADF technique, regression analysis and graphical comparison, Nazir
FDI in Pakistan has less growth impact as compared to other developing economies ( Azam and Khattak, 2009 ). ER volatility is a major driver and risk for foreign investors in a developing economy ( Billmeier and Massa, 2007 ). FDI plays a vital role in stock market performance and the investments from abroad are positively related to the stock prices but this positivity can be seen in the home country financial market ( Baker
Market capitalization (stock market development) and long run economic growth is found to be positively and robustly associated. Economic development is a prerequisite for financial development of any country with stock market development being positively related to economic growth ( Levine and Zervos, 1996 ; Levine, 1996, 1997 ).
Another relationship discussed in this study is the impact of FDI on economic growth. Handsome numbers of studies have been conducted in this context. Domarchi Veliz and Nkengapa (2007) using panel data analysis found that FDI positively affects the growth as host country is provided with updated techniques. Borensztein
FDI in contrary to previous literature does have a positive relative relationship but not as robust as the previous literature due to inefficient governance, bureaucracy and instability in political processes (Athulorala, 2003). Yartey (2008) linked FDI with the rules and regulations, institutional reforms and efficiency in the market strengthening the stock market base leading to increased capital inflows.
The study is based on secondary data for all the sectors listed at KSE. The market capitalization of KSE is taken for the period of 26 years (1985-2011) and for sectors, time span is limited to ten years (2001-2011) due to non-availability of data. The variables for the study include aggregate stock market development, sector wise development, FDI and economic growth. Aggregate market and sector wise development are taken as dependant variables where as FDI and economic growth are the independent variables.
Stock market development is referred to as increase in the market capitalization of the stock market. Market capitalization as a share of GDP is used as an indicator for stock market development ( Nazir
Linear regression model is used to identify the relationship between the stock market development, FDI and economic growth. The regression equation is:
MC/GDP =market capitalization as share of GDP.
FDI =net foreign direct investment.
ER =exchange rate (PKR to dollar).
GDP =gross domestic product.
ɛ´ =error term (based on Adam and Tweneboah (2009) ).
The data is analyzed using different statistical and econometric techniques including correlation analysis, regression analysis, augmented Dickey-Fuller (ADF) approach, Granger causality test, Johansen...