The triple nexus: How foreign direct investment [FDI] and inflation jointly shape Nepal’s gross domestic product [GDP] growth

Abstract

This study investigates the dynamic relationship among foreign direct investment (FDI), inflation, and gross domestic product (GDP) growth in Nepal from 1990 to 2023, focusing on how FDI and inflation jointly affect economic growth. Classical and neoclassical growth models form the theoretical basis for analyzing the interaction between FDI, inflation, and GDP growth. The study analyzes yearly information and fills in missing FDI data from 1992 to 1995 with strong estimation techniques, choosing autoregressive integrated moving average (ARIMA) for its precision. A vector autoregression (VAR) model is used to examine cause-and-effect relationships, along with additional descriptive and diagnostic analyses to confirm the results are trustworthy. The findings indicate that GDP growth Granger-causes FDI inflows, while FDI does not Granger-cause GDP growth. This suggests that economic growth is more crucial for attracting FDI than the reverse, highlighting structural impediments in Nepal's economy that need to be addressed to fully integrate FDI into the economy. However, it is clear that what is required for Nepal to fully exploit the potential benefits of FDI for development is to take a clearly articulated "growth-led" strategy with targeted efforts towards attaining macroeconomic stability and an attractive investment climate. Specifically, we provide suggestions for attaining stable economic growth, addressing structural impediments related to sectoral diversity and regulatory ineffectiveness, and containing stable inflation to create an environment conducive to foreign investment. The challenge that remains to be addressed by Nepal's leaders, therefore, is one of growth, creating sustainable positive stimulus for a long-term pathway of foreign investment and subsequent economic development.