Justification of the study 1.6
This research creates a future reference to researchers, scholars and students who may aspire to take out research on the same or correlated field. Other than that this research intends to give a broader view on how Zambia is performing in line with the outside world. It further alerts on weather exchange rate or interest rate in Zambia supports foreign direct investment. Zambia being a third world state does the FDI inflow promotes economic growth. The study may also be helpful to scholars and researchers in identification of further areas of research on other related studies by highlighting related topics that require further research and reviewing the empirical literature to establish study gaps. The government also stands to benefit from this study as it would be able to understand the factors underlying the dismal performance in the FDI and specifically the role of interest rates. This indeed would help to come up with marketing strategies on how to improve or promote more investors in the country.
Scope of the study 1.6
This study utilized time series data for the period 2007 to 2017, the variables used included Foreign Direct Investment, Exchange Rate, Gross Domestic Product, and interest rates. The focus was placed on the effects of exchange rate and interest rate on foreign direct investment. It will be beyond the scope of the study to look at things beyond the mentioned ones.
This chapter presents the theoretical framework applied in the study and reviews previous studies done on interest rates and foreign direct investments. It contains the theoretical review, determinants of foreign direct investments, empirical review, and conceptual framework.
Literature review 2.1
This units looks at the theories that explains , the effects of exchange rate and interest rates on foreign direct investment. It gives theories that explain and gives deeper understanding on exchange rate, interest and FDI. It further gives theories that show the relations between the variables. This chapter further explains what other authors have written in line with my study.
Exchange rate is an essential component affecting FDI. The eventual importance of exchange rates to the location of FDI was initially suggested by Asiedu (2002). Asiedu stated that different currency areas were responsible for the generation of FDI. Dunning stated that greater fixed capital stakes of an investment showed the possibility of taking into account future movements in exchange rates (Dunning,1993). Goldberg (2011) agrees that exchange rates volatility impact location decisions of MNCs. Other research indicates that exchange rate risk contributes significantly in explaining FDI (Gastanaga et al., 1998).Exchange rate volatility may negatively affect and reduce direct investment. Gastanaga et al., (1998) based on an analysis of macroeconomic factors, institutional and legal frameworks and risk in determining FDI, proved that market size, fiscal deficit, inflation and exchange regime and trade openness were all significant. According to earlier research, exchange rate movements have shown to be relevant and significant to FDI because exchange rate volatility contributes directly to uncertainty in the transaction plan from the countries investing (Behera, 2008).
According to “theory of exchange market or imperfect capital”(Cushman, 1985) companies engage in FDI due to fluctuations in exchange rate. Appreciation or depreciation of exchange rate can affect profitability and costs of company operation. By FDI and by moving operations to a host country many uncertainties caused by exchange rate fluctuations can be reduced. (Singhania, 2011). Interest rate is cost of borrowing and return on savings. Investors will look for low cost funding sources or lower rates and will invest in higher return or higher interest rates. It means capital will move from low rate country to high rate country.(Chakrabarti, 2001) found positive relation between interest rate and FDI in India, while (Anna, 2012) did not found any significant impact on FDI in Zimbabwean economy. External debt (Anna, 2012) Increased external debt/GDP ratio has a negative effect and lower debt/GDP ratio has a positive effect on FDI. Higher loans can be perceived as result of bad economic policies.
Madura and Fox (2011) argue that a firm will invest funds in a country whose local currency is currently weak in order to earn from new operations which may regularly be converted back to the foreign firm’s currency at a better exchange rate. Exchange rate movements affect FDI values because they tend to generally affect the expected amount of cash inflows received from their investments and the amount of cash outflows required to pay to continue operating these investments.
2.3.1 Interest Rates
Agiomirgianakis (2003) defined FDI as capital inflow into a country as a result of investment from multinational business entities. The economic theory which elaborates on ways that capital moves in the globalized economy insist that capital tends to flow to countries with higher ROA as compared to those with higher interest rates (Pholphirul, 2002). Consequently, investment is high in countries that offer better investment returns as well as security in the form of lower interest rates and a better business environment. Capital therefore is higher for countries with lower return rates compared to those with high rates of return.
Singhania (2011) argues that interest rates are normally adjusted to reflect changes in inflation. As a result, interest rates are critical determinants of foreign direct investment. Traditionally, investors will shop for low cost credit sources or lower interest rates and invest it in economies that are promising higher returns. According to Vesarach (2014), who conducted a study on the role of interest rates in attracting FDI in the Asian economies; the results showed that the determinants of FDI are interest rates, inflation, GDP, exchange rates, labor cost, money growth and political rights. The researcher concluded that countries should offer competitive interest rates to attract foreign direct investments in their country.
Foreign direct investment
Hill (2005) defined FDI inflows as the long lasting investments which are outside the investor’s physical or economic boundaries. The beneficiary country of FDI is equipped with capital flow as well as technology flow that will aid in its development. When a country seeks to invest in another, the benefit it seeks to achieve must be higher than the risks it must deal with. UNCTAD (2002) describes three different types of FDI. These are: reinvested earnings, equity capital and other capital which mainly consist of intercompany loans. FDIs create new job opportunities as upon setting of the business, recruitment and training of the locals in the host country is
According to Grazia Ietto-Gillies (2012),prior to Stephen Hymer’s theory regarding direct investment in the 1960s, the reasons behind Foreign Direct In*vestment and Multinational Corporations were explained by neoclassical economics based on macroeconomic principles. These theories were based on the classical theory of trade in which the motive behind trade was a result of the difference in the costs of production of goods between two countries, focusing on the low cost of production as a motive for a firm’s foreign activity. For example, Joe S. Bain only explained the internationalization challenge through three main principles: absolute cost advantages, product differentiation advantages and economies of scale. Furthermore, the neoclassical theories were created under the assumption of the existence of perfect competition. Intrigued by the motivations behind large foreign investments made by corporations from the United States of America, Hymer developed a framework that went beyond the existing theories, explaining why this phenomenon occurred, since he considered that the previously mentioned theories could not explain foreign investment and its motivations.
Conceptual Framework 2.2
Pholphirul (2002) explains the contribution of capital in the movement of the global economy and insists that capital tends to flow to countries with higher return on investment as compared to countries with higher interest rates. Consequently, investment is high in countries that offer better investment returns as well as security in the form of lower interest rates and a better business environment. Capital therefore tends to be more from countries with low rate return to economies with high rate of return. Singhania (201