Abstract:
Foreign Direct Investment (FDI) plays a vital role in the economic development of emerging
economies by providing capital inflows, generating employment, facilitating technology
transfer, and enhancing competitiveness. This study investigates the impact of two key
macroeconomic variables namely, the Colombo Consumer Price Index (CCPI) and the real
exchange rate on FDI in Sri Lanka, using annual time series data from 1991 to 2021 obtained
from the reports of Central Bank of Sri Lanka and World Bank. The Auto-Regressive
Distributed Lag (ARDL) bounds testing approach is employed to examine both short-run
dynamics and long-run relationships. The results confirm the existence of a long-run
equilibrium relationships among FDI, CCPI, and the real exchange rate. The ARDL
estimates indicate that FDI inflows are highly persistent, with the lagged dependent variable
showing strong significance (β = 0.6914, p < 0.01). In addition, CCPI has a negative and
significant effect on FDI (β = –0.0125, p < 0.05), implying that rising domestic prices
discourage foreign investors. In contrast, the real exchange rate shows a positive and
significant effect on FDI (β = 0.6089, p < 0.05), indicating that favourable exchange rate
movements enhance investor confidence and attract foreign capital. The negative and
statistically significant error correction term (β = –0.0374, p < 0.01) confirms the presence
of long-run equilibrium, with approximately 3.7% of disequilibrium corrected each year.
The findings provide valuable insights into the macroeconomic determinants of FDI in Sri
Lanka and offer useful implications for policymakers and potential investors.
