The Nonlinear and Interaction Effects of Risk Factors on FDI Inflows: Evidence from Developing Countries in Asia

Abstract

Purpose – The purpose of the study is to analyze the nonlinear and interaction effect of four risk factors on FDI inflows for twenty developing countries in Asia. Design/Methodology/Approach – Panel regression with balanced panel data was conducted using fixed effect and GMM models. FDI inflows as a percentage of GDP for each country were adopted as the dependent variable. Four types of risk factors were used for independent variables, such as political, financial, exchange rate, and inflation rate risk. Economic growth and export orientation were controlled. In order to account for potential persistence in the FDI series, a lagged dependent variable is also included in the dynamic model specification. Findings – First, political and financial risk and export orientation show negative impacts on FDI inflows, whereas inflation risk and economic growth have positive impacts. Second, inflation risk has a non-linear effect on FDI inflows. That is, when inflation goes beyond a threshold level, it appears to result in less FDI inflows. Third, political risk proves to have a significant interaction with financial risk and inflation. Also, financial risk turns out to have significant interaction with inflation. Research Implications – To attract more FDI inflows, Asian developing countries need to improve political stability first, while trying to reduce external debts and to accelerate economic growth.