The Explorer Islamabad: Journal of Social Sciences ISSN (E): 2411-0132, ISSN (P): 2411-5487 Vol-1, Issue (9):314-319 www.theexplorerpak.org
FACTORS AFFECTING INVESTMENT BEHAVIOR IN PAKISTAN Amtul Hafeez1, Saba Safdar2 Assistant Professors at from National University of Modern Languages, Islamabad, 2Graduate from NUML, Islamabad
1
Corresponding Author: Amtul Hafeez H# 87, st# 35B, I-9/4, Islamabad amtulhafeezgondal@yahoo.com Abstract: The objective of the study is to analyze the factors that affect investment behavior in Pakistan over the time period 1980-2011. Augmented Dickey-Fuller (ADF) is used to check the stationary level of the variables in the model. The ARDL (Auto regressive distributed lay model) is applied to check the existence of a long-run relationship between variables. The study employs Error correction model to find the short run adjustments for the investment behavior in Pakistan. The results show that domestic and foreign savings, gross domestic product are found to have significant positive effect on investment. However interest rate and inflation rate have strong negative effect on investment behavior in Pakistan.
Key Words: Investment, Savings, Interest Rate, Economic Growth INTRODUCTION National investment is a macro variable which plays a significant role in economic growth to stabilize the inflation rate and also to provide employment opportunities in economy. The employments situation is promoted through investment in developing countries. Investment in capital goods plays a critical role in both the cyclical and long run performance of any economy. Being the main components of the aggregate demand, it is leading sources of economic growth in the long-run. That is why the capital accumulation has traditionally been given a prime place in the literature on economic growth. The neoclassical theory of economic growth emphasizes that Investment in physical and human capital into the production process (Solow 1956). The decade of 1980s, witnessed a decline in investment in developing countries. This provides source of inspiration for empirical research into what determines the private-sector investment. The investment and specially the private investment to enhance economic growth, becomes more important to declare liberalization. That is why as the engine of economic growth and development has been accorded the focal place in developing countries. Given the dominant significance of private sector investment, it is vital to investigate into factors affecting investment decision. There are different studies considering different aspects of investment in Pakistan (Khan 1997;
Naqvi 2002). This study attempts to estimate private investment demand function, using ARDL model over the period 1980– 2011. The objective is to estimate a well specified private investment function that must be consistent with economic theory. Objectives 1. To identify the correlation between investment and macroeconomic variables. 2. To identify the factors that negatively affects investment behavior in Pakistan. 3. To suggest the policies that government can take to increase the investment level. Research Questions What are the factors that affect the behavior of investment in Pakistan? DETERMINANTS OF INVESTMENT Private investment is determined mainly by level of savings, domestic output, the real interest rate, and public loans in developing countries (ServÊn and Solimano 1992). The neoclassical theory of investment, based on the work of (Jorgenson 1963), treats the value of the capital stock desired by a competitive enterprise as a positive function of its output level. Accelerator theory also suggests that as demand or income increases in an economy, so does the investment made by firms. Furthermore, when demand levels result in an excess in demand, firms increase investment to match demand. Foreign savings have positive impact on investment but not as much as domestic savings. It is studied
314
that income level is directly related with household savings which are very necessary for investment. The real interest rate is also considered an important variable in determining the level of investment by neoclassical theory. A negative relationship is expected theoretically because of increases in the interest payable being disincentive to investment. However there could positive relationship between investment and real rate of interest rate, because higher real rate of interest would increase savings, volume of domestic credit will increase as a result, and equilibrium investment be higher (McKinnon 1973). High rates of interest rate increases investment through saving according to (Munir, et al. 2010). The other important factor that affects the private sector investment is inflation rate. It is observed by Commodity price have very strong affect on investment. If the price of commodity increases then investment behaves positively because the investors are interested to invest for earning more profit. It is found that public loans generate funds for investment if these funds are used for productive propose then public loans are good for growth and investment (Akram 2011). However, public debt has significantly negative impact on per capita growth and investment both in short and long run in case of Pakistan. DATA AND METHODOLOGY The purpose of study is to investigate the behavior of investment in Pakistan. Since the time series data shows the discontinuity before the year 1980, the study is based on data from 1980-2012. Main data sources are Economic Survey of Pakistan (various issues) and World Bank’s annual reports. Table 1 gives the description of variables. Table. 1: Variables Description Variables Description
Measurement and Data Source
NI
National investment
As percent of GDP, Economic Survey
DS
Domestic savings
As percent of GDP, World Bank Report
FS
Foreign savings
As percent of GDP, Economic Survey
GDP
Gross domestic product
Growth rate , World Bank Report
RIR
Real interest rate
Annual percentage, World Bank Report
PL
Public loan
As percent of GDP, Economic Survey
INF_r
Inflation rate
Annual percentage, World Bank Report
Investment Model The functional form of model is as fallows; NI = f (DS, GDP, FS, RIR, PL, INF_r) … (1) The econometric equation of the investment model is as follows NI = β0 + β1 DS + β2GDP + β3FS + β4PL + β5RIR + β6INF_r + µ0…. (2) Dependent variables National investment In economics investment mean accumulation of newly produces entities, such as factories, houses, goods inventories and machinery in country. In finance, investment means putting money in an asset to expect that their capital value will appreciate in future in the form of dividend or interest earnings. National income identity is: GDP = Consumption + Investment + Government Expenditure And we have Investment = GDP - Consumption - Government Expenditure Independent variables Domestic savings Domestic savings means the process of setting aside some portion of our income for some future use. Saving is that portion of our income which is left after consumption. S = Y - C (portion of income that left after consumption) Foreign savings Foreign savings or foreign capital inflow is the movement of foreign capital into domestic economy. These saving are calculated as excess of foreign receipts over foreign payment in terms of financial investments. It is expected that foreign savings positively affect the level of investment in the country. Gross domestic product The total market value of the final goods and services produced in the country in a specific time period of one year is known as gross domestic product (GDP). Higher productivity in the economy is likely to increase the level of investment in the country. That is there is positive relation between GDP and investment level. Real interest rate Real interest rate is a rate which is adjusted after removing the inflation effect to show the real cost
315
of funds to the borrower and real profit for lender. It is expected to have negative impact on investment behavior in Pakistan. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate. Real Interest Rate = Nominal Interest Rate Inflation (Expected or Actual) Public Loans Public sector loans show that how much government borrows from different sources every year. Government uses the loans borrowed from internal and external sources on different expenditures of the state. Increase in public sector loans is likely to increase the level of investment in Pakistan. Inflation Rate Inflation rate is a rate which shows the rise in general price level of goods and services in the country. Inflation rate is used to measure the element of uncertainty in economy. Inflation rate is expected to have negative relation with the investment level in the country. ESTIMATION AND RESULTS Unit Root Tests This study uses Augmented Dicky-Fuller (ADF) unit root tests to all variables in order to check the stationary of data. The results of ADF are given in Table 2. We find that all variables are either I(0) or I(1) and none of the variables is of I(2) or higher order. Therefore we apply ARDL to undertake long run analysis among variables. The results are given in Table 3 and Table 4. Hypothesis: H0 : Time series are non-stationary. H1: Time series are stationary. Table. 2: Results of augmented dickey-filler unit root test (intercept and trend) Variabl t-statistics Prob Order es of Integ NI ADF value -4.323* 0.0123 I(0) 1% level -3.580 5% level -3.22 DS ADF value -5.409* 0.0006 I(1) 1% level -4.319 5% level -3.584 FS ADF value -4.337* 0.009 I(0) 1% level -4.296 5% level -3.568 GDP ADF value -6.886* 0.000 I(1) 1% level -4.309 5% level -3.574 PL ADF value -4.960* 0.0023 I(1) 1% level -4.323 5% level -3.580 RIR ADF value -6.297*
INF_r
1% level 5% level ADF value 1% level 5% level
-4.309 -3.574 -6.246* -4.309 -3.574
0.0001
I(1)
Long Run Analysis Co integration is applied to find out whether there exists a long run equilibrium relation among the variables. The study uses the bounds testing procedure to check the existence of a long run relationship between the dependent and its explanatory variables. The order of lags for bound testing approach is obtained from Unrestricted Vector Auto regression by means of the minimum value of Akaike Information Criteria, Schwarz Bayesian criteria and Hannan-Quinn information, and the lag length of order (2) is selected. In the first step, we select a lag order because the computation of F-statistics for co-integration is very sensitive to lag length. There are two critical bounds to test F statistics. The lower bound assumes that the variables are integrated at level and there is no co-integration among the variables while the upper bound assumes that the variables are integrated at first difference I(1) and there exist co-integration among the variables. If F- statistics is higher than the upper bound than H0 of no co-integration among variables is rejected. If F- statistics is lower than the lower critical bound than null hypothesis of no cointegration is accepted which means that cointegration does not exist. If the F-statistic falls between the critical bounds then the test is considered inconclusive (Pesaran, et al. 2001) Auto-regressive Distributed Lag Model Many tests as Engle and Granger (1987) residual based test, and Johansen (1988) maximum likelihood based test are commonly used in literature for conducting the co-integration. However, these techniques face many problems like low power and stationary problems. These tests do not capture the effect of small data set. To overcome this problem, the present study applied the ARDL approach proposed by (Pesaran, et al. 2001). This study extended the ARDL approach to co-integration. ARDL have superiority on other cointegration techniques. 1). it can be applied when the variables are of I(0) or I(1) or mutually integrated, but still it is pre-requisite that none of the variable is of I(2) or higher order. 2). It cares the problem of endogenity. 3). This approach also removes the problems associated with the omitted variables and autocorrelation. The estimates obtained from the ARDL approach to co-integration are unbiased and efficient since they avoid the
316
problems that may arise due to serial correlation. 4). comparing to other VAR models, ARDL technique to co-integration can accommodate greater number of variables. 5). ARDL approach performs better and gives more robust results in case of small data set. A dynamic Error Correction Model (ECM) can be derived from ARDL through a simple linear transformation. ECM gives the short run coefficients without losing the long run information. Econometric presentation of models is given as follows. ΔNIt = α0 + α1NI t-1 + α2DSt-1 + α3FSt-1 + α4GDPt-1 + α5PLt-1 + α6RIRt-1 + α7INF_rt-1 + 1ΔNIt-1 + ΔDS + ΔFS + Δ GDPt-1 + 2 t-1 3 4 5ΔPLt-1 + 6ΔRIRt-1 + 7ΔINF_rt-1 + Et……………….(3) The coefficients s measures the short run dynamics of the model whereas s represents the long run relationship. Et is the disturbance term in this equation. We develop the hypothesis for long run relationship of variables; H0: αs = 0 (No long run relationship) H1: αs ≠ 0 (Long run relationship exists) Once the presence of co-integration between dependent and independent variables is confirmed then we move to estimate the long run coefficients of growth model and the associated ARDL of error correction model for short run coefficients. In both the long run and short run model the lag length are specified on the basis of Schwartz Bayesian Criteria. ΔNIt = α0 + 1ΔNIt-1 + 2ΔDSt-1 + ΔGDP + ΔFS + 3 t-1 4 t-1 5ΔPLt-1 + 6ΔIRt-1 + 7ΔINF_rt-1 + θ Ect-1 …. (4) Table 3 shows the results of Wald test. Table. 3: Results of Wald Test Test statistics Values
Prob.
T statistic
3.0717*
0.0030
F-statistic
6.9741**
0.0035
chi-square
27.8192
0.0002
Note: The calculated statistics indicated by ** and *are significant at 5% and 1 % level of significance. Table. 4: Long run Estimates of Investment Behavior Variables Coefficients t-statistics DS 0.257 2.516* FS 0.149 1.936**
GDP PL RIR INF_r R-square Durbin Watson
0.724 0.029 -0.239 -0.344 0.770 2.193
3.280* 1.633 -1.696*** -2.296* 2 Adjusted R F-statistic
Note: The statistics indicated by ***, ** and *are significant at 10%, 5% and 1 % level of significance. We find that one unit increase in domestic savings is likely to bring 25% increase in investment level in the long run and 12% in short run. One unit increase in foreign savings brings about similar increase of 15% both in long run and short run. We analyze that domestic saving are more important for national investment to increase in the long run. GDP is one of the major determinants that effect investment behavior. The results show that 1 percent increase in GDP growth brings a significant increase of 72% increase in investment level in the long run. However an increase of 37% is found in investment in short run. The estimation result shows that public sector loans have positive but insignificant affect on investment behavior in the country both in long as well as short run. There are two types of effects resulting from public loans. One is that the increase in public loans can increase the investment level both in long run and short run. The second effect is that the increase in public loans can decrease the investment level as major part of these loans is spent on the other nondevelopment projects and to finance the budget deficit. The resulting effect of public loans on investment behavior is though positive but insignificant. One unit increase in Interest rate will bring decrease of 23% in investment in long run. And 1 unit increase interest rate will decrease our investment by 9% in short run, because investment is negatively related with interest rate. People prefer to save more as to earn more interest so physical investment is decrease in short run. Inflation rate is also negatively related with investment. According to the estimation results 1 unit increase in inflation rate will bring decrease of 34% in investment in long run and 20% decrease in short run. This is so because when price increases, the factors of production become expensive and demand is discouraged. It will lead to decrease the investment level in the country. Short Run Analysis After getting the estimation results of ECM it is proved that the values of all variables are significant. The results show that there exist short
317
run relationship between dependent and independent variables. The variables like DS, FS, GDP, and PL have positive and significant impact in the short run and play very important role in determining national investment behavior in Pakistan. The interest rate and inflation rate have negative and significant impact in short run. Table. 5: Results of Error Correction Model Variables Coefficient t-statistic DS 0.127 1.892** FS 0.157 1.681*** GDP 0.371 2.969* PL 0.037 -1.514 RIR -0.090 -1.822*** INF_r -0.204 -1.839*** NI 0.216 1.912** ECM(-1) -0.265 -3.216* R-statistic 0.579543 Adjusted R0.402508 statistic Durbin Watson 2.213425 F-statistic 3.273613
Note: The calculated statistics indicated by ***, ** and *are significant at 10%, 5% and 1 % level of significance. The value of error correction term -0.26 which shows that 26% backward adjustment towards the equilibrium is taking place. CONCLUSION The purpose of the study is to identify the link between investment and other macroeconomic variables like investment behavior and domestic and foreign savings, GDP, public sector loans, interest rate and inflation rate. The study contains the long run as well as short run analysis between dependent and independent variables over the time period of 1980-2011. It is concluded that there exists long run and short run relationship among the above mentioned variables. The positive and significant impact of domestic and foreign savings, GDP, public sector loans is found on investment behavior in Pakistan. However impact of interest rate and inflation rate is found to be negative on investment behavior. Estimation results of ECM show that short run relationship is also present in the economic model that we use in our study. The trends of relation are found similar both in short run and long run for all variables. The study suggests that; Government can encourage the households to save more so that more funds can be provided to finance investment.
Government can encourage the producers to enhance the production so that further investment can take place in the country. Measures can be adopted to reduce the inflation rate and interest rate as these are likely to discourage the investment level. REFERENCES Akram, Naeem 2011 Importance of Public Debt on Economic Growth of Pakistan. Center of Poverty Reduction and Social Policy Development, Islamabad. Engle, Robert F., and Clive WJ Granger 1987 Co-integration and Error Correction: Representation, Estimation, and Testing. Econometrica: Journal of the Econometric Society: 251-276. Johansen, Soren 1988 Statistical Analysis of Cointegration Vectors. Journal of Economic Dynamics and Control 12(2): 231-254. Jorgenson, Dale W. 1963 Capital Theory and Investment Behavior. The American Economic Review 53 (2): 247-259. Khan, Ashfaque H. 1997 Foreign Direct Investment in Pakistan: Policies and Trends. The Pakistan Development Review 36(4): 959-985. McKinnon, Ronald I. 1973 Money and Capital in Economic Development. Brookings Institution Press. Washington DC. Munir, Rahila, Rehmat Ullah Awan, and Zakir Hussain 2010 Investment, Saving, Interest Rate and Bank Credit to Private Sector Nexus in Pakistan. International Journal of Marketing Studies 2(1): 140-146. Naqvi, Naveed H. 2002 Crowding-in or Crowding-out? Modelling the Relationship Between Public and Private Fixed Capital Formation Using Co-integration Analysis: The Case of Pakistan 1964-2000. The Pakistan Development Review: 255-275.
318
Pesaran, M. Hashem, Yongcheol Shin, and Richard J. Smith 2001 Bounds Testing Approaches to the Analysis of Level Relationships. Journal of Applied Econometrics 16 (3): 289-326. Serven, Luis, and Andres Solimano 1992 Private Investment and Macroeconomic Adjustment: A Survey. The World Bank Research Observer 7(1): 95114. Solow, Robert M. 1956 A Contribution to the Theory of Economic Growth. Quarterly Journal of Economics 70(1): 65–94. © 2015“The Explorer Islamabad” Journal of Social Sciences-Pakistan
319