FDI and Growth: The Role of Local Financial Markets

This study investigates the linkage between Foreign Direct Investment (FDI), Financial Market Development (FMD) and economic growth (Growth). It focuses on two main aspects: the nexus between FDI and growth and the role FMD plays in that relationship. While it has been fairly established that financial sophistication -in credit and stock markets- is essential for the benefits of FDI to register in an economy, the part played by bond markets has not been assessed. Therefore, the aim of this study is to fill this gap, particularly in the context of an emerging African economy, South Africa. The study mainly employs Vector Error Correction Model (VECM) using estimators over the period 1987-2011, to test for Granger causality amongst FDI, FMD and growth in South Africa. It concludes that FMD and FDI have statistically significant causal relationship on growth. Therefore, beyond chasing FDI, it is of utmost importance to make concerned efforts to upgrade the financial sector to allow South Africa exploit FDI more efficiently in fostering growth.