Determinants of foreign direct investment in Sri Lanka

Sri Lanka is moving towards achieving a per capita income of US 4, 000 by 2016 and it has to maintain a growth rate around 8 per cent per year to realise the expected target. However, internal investment capability of the country is limited due to low domestic savings. Therefore, Sri Lanka has to rely on external finance such as foreign Direct Investment to achieve expected prosperity. This paper investigates the determinants of Foreign Direct Investment in Sri Lanka and evaluates the attractiveness of India, Sri Lanka, Bangladesh and Pakistan for foreign direct investment during the period of 1975-2012. Fully modified least squares (FM-OLS) regression model was fitted to estimate the determinants of foreign direct investment. Attractiveness of the selected countries for foreign direct investment was evaluated using an index. Empirical results revealed that GDP growth rate, inflation, infrastructure quality, lending interest rate, labour force, exchange rate, and corporate income tax were significant determinants of FDI in Sri Lanka during the period of 1975 -2012. Main feature of the variables which are determinants of FDI is that they are directly associated with the cost of production of the investors. Therefore, it can be interpreted that the main motive of the foreign investors in Sri Lanka is to reduce the cost of production by improving the efficiency of operations. FDI index suggests that India and Bangladesh were more attractive for FDI inflows over Sri Lanka and Pakistan. Market seeking investors are keen on the potential large market size of India and Bangladesh over Sri Lanka. Therefore, the motive of the investors is important in evaluating determinants of foreign direct investments in a country. DOI: http: //dx. doi. org/10. 4038/jur. v2i1-2. 7849 J. Univ. Ruhuna 2014 2: 4-13