Thesis

THESIS
THESIS
The Impact of Inflation, Foreign Debts and Foreign Direct Investment (FDI) on Economic Growth of Pakistan
A Thesis Submitted To Department of Commerce
Superior University
In Partial Fulfillment of the Requirement For The Degree of
Master in Commerce
Submitted by: Muhammad Usman Asad (Mc10225)
Supervised by: Prof. Habib Asghar
2011
SUPERIOR UNIVERSITY, LAHORE
THESIS
THE IMPACT OF FOREIGN DEBTS, FOREIGN DIRECT INVESTMENT AND INFLATION ON THE ECONOMIC GROWTH OF PAKISTAN Following chapters will be discussed in this whole thesis: CHAPTERS Introduction Literature Review Theoretical framework Methodology/Data Analysis Conclusion Recommendations References
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DEDICATION
I am dedicating my thesis to my parents and respected teacher Prof. Habib Asghar who has played a vital role in my thesis and has guided me at every step with his precious ideas. It will have a lot of benefits for me in my future life.
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DECLARATION
I hereby declare that this project is entirely my own work and that any additional sources of information have been duly cited. I hereby declare that any Internet sources published or unpublished works from which I have quoted or draw references fully in the text and in the content list. I understand that failure to prove this will result in failure of this project due to plagiarism. I understand I may be called for viva and if so must attend. I acknowledge that this is my responsibility to check whether I am required to attend and that I will be available during the viva periods.
Signed
Date.
Name of Supervisor
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CERTIFICATE
Certified the research work complained in this thesis titled The impact of inflation, foreign debts, foreign direct investment on economic growth of Pakistan had been carried out and completed by Muhammad Usman Asad under my supervision during his M-com.
Supervision: _______________ Date: ____________
Submitted Through:
Prof. Khurram Program Manager Department of Commerce Superior University, Lahore Controller of Examinations Superior University, Lahore
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ACKNOWLEDGEMENT
I would like to thank the following persons without whose guidance this dissertation could not have been completed.
First of all I would like to thank my (
) who always guides me in every walk of my life.
Secondly, I would like to express my sincere appreciation and gratitude to my supervisor Prof. Habib Asghar for his guidance and insight throughout in making my dissertation and especially, his invaluable suggestions and comments that really guided my research and also helped me to structure my dissertation. Thirdly I am also very indebted to my best friends, my father and mother for their continuous support. I owe a lot of their unconditional love and understanding. Well, their suggestions allowed me to think in many different ways. Most importantly, they continually helped me improve my confidence. There were certain times, when I used to say that I just did not think I could go on with my studies, but they always knew just what to say to get me back in the race. They really very special entities of my life. What a journey! I will never stop admiring them.
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TABLE OF CONTENTS
ABSTRACT:................................................................................................................................................ 8 2.1INTRODUCTION: .................................................................................................................................. 9 2.2 LITERATURE REVIEW: .................................................................................................................... 22 2.3 THEORETICAL FRAMEWORK:... 35 2.3.1 INFLATION:..35 2.3.2 FOREIGN DEBTS:.....36 2.3.3 FOREIGN DIRECT INVESTMENT:.....36 2.4THEORETICAL FRAMEWORK MODEL: ......................................................................................... 36 2.5 METHODOLOGY/DATA: .................................................................................................................. 37 2.6 ANALYSIS: .......................................................................................................................................... 37 2.6.1 SCATTER PLOTS:......38 2.6.2 CORRELATION:.....39 2.6.3 REGRESSION:.42 2.6.4 CRONBACH 'S ALPHA: ....44 2.7 CONCLUSION:.45 2.8 RECOMMENDATIONS: ..................................................................................................................... 45 2.9 REFERENCES:46
THESIS
ABSTRACT
This study estimates the impact of inflation, foreign debts and foreign direct investment on economic growth of Pakistan. Scatter plots, Pearson correlation, Regression techniques and Cronbachs alpha have been used for analysis. I found that foreign debts and inflation has negative impact but foreign direct investment (FDI) has positive impact on economic growth of Pakistan. Due to inflation and foreign debts the economy of Pakistan effected. The result and data has discussed in depth in this report. As a result of bad economy the value of rupee has fall against dollar thus the government should take further steps to improve the economy of Pakistan. There are also several limitations as well as future research implications at the end of this research study. Keywords: Inflation, foreign debts, foreign direct investment and economic growth of Pakistan
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2.1INTRODUCTION:
conomic growth of any country depends on basically internally or externally factors. The economic growth of Pakistan depends on these factors such as foreign direct investment, foreign debts, inflation, politically stability etc. Foreign direct investment,
foreign debts and inflation have impact on economic growth of Pakistan because whole economy of Pakistan depends on especially foreign debts and inflation. If government of Pakistan improves these independent variables the economic growth of Pakistan is automatically improves. If the economic growth of Pakistan improves the exchange rate also stable. If exchange rate is stable it means the overall economy of Pakistan is better. Borrowing from abroad is a normal part of economic activity. Development countries like Pakistan will need to borrow finance for their development; however, they must enhance their capacity and performance of debt. In other words, the borrower must continue to service liabilities of its foreign debt in an orderly and stable micro economic framework. Moreover, the borrowed resource must be utilized effectively and productively so that it generates economic activity. Prudent management of debt is therefore essential to prevent the debt crisis. Foreign debt and liabilities at the end of March FY08 stood at $45.9billion. This represents an increase of $ 5.4 billion, showing an increase of 13.3% in stock at the end of FY07.
The purpose of the study is to check the impact of foreign direct investment, foreign debts and inflation on economic growth of Pakistan. The main purpose of this study is confirmed or verifies the impact of independent variables on dependent variable. Another purpose of this study is to check the relationship between these variables. This study has great significance or importance because economic growth of Pakistan is based on these three independent variables which are foreign direct investment, foreign debts and inflation. Due to poor economic policies by the government of Pakistan faces the pitiable and meager conditions. If government improves these deprived conditions then economic growth of Pakistan can automatically improved.
THESIS Pakistan's foreign debt and liabilities is created of all government debt denominated in foreign currency loans received by enterprises Government ownership of more than 50%, and foreign debt of the private sector which is registered in the State Bank of Pakistan and finally the benefits of a foreign currency convertibility guarantee of SBP. Pakistan the total amount of foreign debt and foreign exchange liabilities grew at a compound average rate of only 1.2 % per year during 2001-07 rising from $ 37.2 billion in 2001 to $ 40.5 billion by the end June 2007. On the other hand, in the first nine months 2007-08 fiscal years, the stock of foreign debt grew by 13.3%. Since 1970s public debt burden is the primary development challenge for the economy of Pakistan to lessen in order to follow a road that leads in the direction of sustainable and reasonable growth for the development of the country. Debt service as a result of the budget deficit has increased to more credit creation. Today, Pakistan has been plunged into a debt trap. This is highlighted by the economist in the long term and
for generations to come can be very dangerous. The result of this trend in today's social spending on
social sector allocation in the future will only be reduced but not too bad. This is creating real economic imbalances. Budget deficits are financed in four ways:
By printing money Borrowing from abroad Borrowing domestically and Running down foreign exchange reserves
In late March 2010 the stock of outstanding public debt, working the above would imply an increase of at least Rs. 88.2 billion public debts, for every percentage point raise in fiscal deficit the impact on growth less than clear. This growing debt stock will produce an annual debt service liability over Rs. 7 billion. Looking at the structure of budgetary expenditures, debt service (including repayment of foreign loans) expected to account for 27% of total expenditures for the current fiscal year. Given the rigidity of some the other major heads of expenditure, such as security costs, any increase in debt service would necessarily break the requirements in other areas of spending, including possibly
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THESIS the development costs or expenses of vulnerable population segments. Clearly, this would be an undesirable situation, since it can lead to reducing the long term prospects of Pakistan's growth, or reducing support for vulnerable groups in society - the exact opposite of the intended result. Public debt is one of the major economic issues facing the governments of South countries. There is a lot of debate on foreign debt issue but domestic debt has not occupied the central stage in research and economic planning. External debt has therefore, historically received the attention it deserves. Until the late 1990s, developing countries did not address the risks and challenges of internal debt. Pakistan is using domestic borrowing to pay the foreign debt servicing. The growth of public domestic debt in Pakistan has not been restricted to make sure that the plenty of resources are available after debt servicing to finance government expenditures of various nature. There are several reasons behind the domestic public debt. First, it is used to finance the budget deficit. Secondly, it is implemented and used monetary policy through open market operations. Third debt instruments of domestic financial markets need to grow and open. Domestic credit to the economy could be as serious allegations. Government revenue in domestic debt service is an important part absorbed. Thus, domestic debt stock of domestic debt service than it is harmful for economic growth. In addition, shallow financial markets, as domestic debt increases, interest rates in the short-term instruments held by a large amount of debt is rising.
There is a scarce literature on the effects of domestic debt on the economy of Pakistan. In addition, the available studies on public debt and economic growth have typically focused on external debt. This study aims at filling this gap by using the most recent data from the period 1972 to 2009 to Pakistan investigates the impact of domestic debt on economic growth.
Pakistan economy has remained dependent on foreign inflows for economic growth and using co integration analysis, this paper examines the relationship between foreign assistance and economic growth during 1972 to 2010.
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THESIS In line with a sharp drop in global flows of Foreign Direct Investment (FDI), which fell 32 % in 2009 according to estimates of the International Institute of Finance (IIF), direct investment from this foundation without a large reduction in Pakistan. For the period July-April 2009-10, foreign investment totaled U.S. $1.8billion compared with U.S. $3.2 billion in the same period of FY09. This represents a decrease of 45%. A large part of the fall of foreign direct investment for the period was registered under the telecommunications (a net reduction of U.S. $ 607 million), and Financial Services (a decrease of U.S. $548 million). Combined, the decline in these two sectors, which are related to some "lumpy" transactions last year, amounted to 81% of overall decrease in foreign investment in 2009-10.
Levels of investment in some sectors remained healthy, including oil and gas (FDI of U.S. $ 605 million), Communications (U.S. $222million), Transportation (U.S. $104 million), Construction (U.S. $ 86 million), Pulp and paper (U.S. $ 81 million). Despite a steep drop, the flow of FDI in financial services registered in U.S. 133 million for the period. Not achieved for foreign direct investment (FDI) as an important factor of the external resource flows to developing countries over the years, and has become a major part of the capital structure in these countries, although its share in the global distribution of foreign direct investment continued to remain small or even decline. The role of foreign direct investment (FDI) recognized widely as a factor to promote growth in developing countries (Khan, 2007). And usually affect the host economy for foreign direct investment (FDI), increase employment, enhance productivity, export and transfer of technology to enhance the speed of expansion. The potential to host economic benefits of foreign investment, and the use of local raw materials and to facilitate the exploitation, management and modern marketing techniques, access to new technology, reduce, foreign exchange inflows to increases in the current account. During the past last two decades, as seen many countries around the growth and the world in large economies with the faster growth in international transactions, particularly in the form of foreign direct investment (FDI). Grown increasing share of net FDI in the GDP of the world five times during the eighties and nineties and to take the causes and consequences of foreign direct investment (FDI) and economic growth a subject of growing interest. This paper is an attempt to make a contribution in this text, by analyzing the existence and nature of victims, if any between
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THESIS direct investment (FDI) and economic growth. And it is used the focal point Southern region and South East Asia where growth in the economic activities and foreign direct investment (FDI) was one of the most obvious. The literature on FDI and economic growth generally points to a positive relationship between the two variables, and offers several, standard explanations for it. In principle, economic growth may induce FDI inflow when FDI is seeking consumer markets, or when growth leads to greater economies of scale and, hence, increased cost efficiency. On the other hand, FDI may affect economic growth, through its impact on capital stock, technology transfer, skill acquisition, or market competition. FDI and growth may also exhibit a negative relationship, particularly if the inflow of FDI leads to increased monopolization of local industries, thus compromising efficiency and growth dynamics. Empirically, the positive effect of economic growth on FDI and also the positive and negative effects of FDI on economic growth have been identified in the literature. However, very few studies attempt to directly test for causality between FDI and growth. Both find that FDI-to-growth causality is more likely to exist in more open economies. This paper extends the line of work mentioned above, and provides a direct test of causation between FDI and economic growth in one of the most vibrant in the world: South and Southeast Asia. Granger causality tests are used, the analysis reveals the existence of a wide variation in the growth of the causal relationship of FDI in different countries, which means that any generalization of causality between variables can be a problem. To better understand the variation across the country, the paper extends the analysis using regression techniques, identifies institutional variables that affect the relationship to foreign direct investment growth. Now the importance of institutions of the dynamics of economic well-recognized, but widely because of differing institutional reforms in different countries during the eighties and nineties is indispensable for the enclosure of institutional factors for the analysis at hand. To determine their suitability for the growth of the relationship to foreign direct investment, and separate from the direct impact on foreign direct investment or growth alone, the analysis focuses on the implications of the interaction of explanatory variables. The results showed that enhanced foreign direct investment to the growth of the largest causal trade openness, rule of law is more limited, and declining revenues, bilateral aid and the low level of income in the host
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THESIS country. Growth of foreign direct investment to causation, on the other, reinforced by more political rights and the rule of law is more limited.
In recent decades under the changing manners of international transactions and cross-border mobilization of production factors, foreign direct investment (FDI) attracted great attention not only in developing countries but also in developed countries. The open FDI regime forced the host countries to adopt greater deregulation policies and reliance on market forces in their economies. Most developing countries such as Pakistan now considered FDI as the major external source of funding to meet obligations of resources gap and economic growth, however it is difficult to measure economic effects with precision. Nevertheless, various empirical studies showed a significant role of inward FDI in economic growth of the developing countries, through its contribution in human resources, capital formation, enhancing of organizational and managerial skills, and transfer of technology, promoting exports and imports and the network effect of marketing. The other positive spillover effect was that the presence of foreign firm helps expand infrastructure facilities, which makes it easier and profitable for local firms to crowd-in (Lemi, 2004).
Unfavorable effects occur with competition for scarce resources and skilled manpower is limited, due to strategic motives by subsidiaries of multinational corporations (MNCs) or the height of the technology gap between domestic and foreign companies. There were also other costs associated with the flow of foreign direct investment, such as restrictive trade practices by foreign companies and repatriation of profits and taxes forgone in the case of tax exemptions. Net social effects also vary depending on the nature of foreign direct investment, and the motives behind the internal processes, and policies of the host country government. Many factors have made Pakistan an attractive place for foreign investment.
Firstly, economy Pakistani and showed the response and the potential ability to cope with external shocks and reduce risk in response to various major events of regional and global, for example, the nuclear explosion (1998), and the bombing against professional French in Karachi (2001), 9 / 11, began in 2001, which put Pakistan in the front line once again and aid from Washington to flow again. Subsequent events include: the war in Afghanistan, and the attack on
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THESIS the Indian Parliament (2001) that led to the mobilization of Indian troops, the war in Iraq in 2003, and the Karachi Stock Exchange (KSE) crisis and a massive earthquake (2005). Secondly, and Pakistan with then population of $150 million, which provides a big market of consumer goods, and the growing middle class with purchasing power sufficient and provide cheap labor, which reduce the cost of production and a strategic geographical location in Central and Southeast Asia. Thirdly, Pakistan has a world-class physical infrastructure, which was necessary for investment. The country inherited strong institutions from the British, and provided adequate communication infrastructure for foreign investors. Finally, there was also a strategic consideration for increasing FDI in Pakistan having implications for global security (Hussain, 2003).
In this fiscal year export rose by only 3.4% of the $13.45 billion rise to $139 billion. Pakistan exports include a number of projects, cotton, leather, rice, industrial textiles and sporting goods. Imports from goal setting to decline by 2.1% to 28 billion yuan from the 2006-07 level of $28.6 billion last year (the Republican Party 0.2006-07). The potential advantages of the FDI on the host economy are it facilitates the use and exploitation of local raw materials, it introduces modern techniques of management and marketing, it eases the access to new technologies, Foreign inflows could be used for financing current account deficits, finance flows in form of FDI do not generate repayment of principal and interests (as opposed to external debt), it increases the stock of human capital via on the job training. The local enterprises are able to learn by watching if the economic framework is appropriate (Bhagwati, 1994) it stimulates the investment in R&D (Calvo and Robles, 2003). The volume of foreign direct investment (FDI) significantly for the developing countries during 1985 to 2000. The share of developing countries in the world, and foreign direct investment flows emerging from 17.4% from 1985 to 1990 to 26.1% during the period 1995-2000, for Pakistan, the quantity of FDI inflows from $0.24 billion in 1990 to $55 billion in 2007 (WDI indicators 2008).
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THESIS While looking at the pattern of Foreign Direct Investment in Pakistan, which has been very impressive in recent years. FDI has been increased from $ 322 million in 2000-01 to $3.52 billion in 2005-06 and expected to be $6billion in 2006-07 according to government pronouncement. Earlier, it has different trends, as Pakistan received little amount of FDI, because Pakistan was heavily dependent on the debt. By 1996 its share raised to almost 50 % of net resource flows. Considering the openness of the investment regime, foreign investment activity to date has been registered a substantial increase in FDI flows. Pakistan was among the first few countries in the region to open up the market in early nineties. Pakistan does not only have an enviable record of accomplishment of economic growth in sixties but still it has the potential to repeat the past. It still enjoys some economic fundamentals. The country has often come out with pro-investment policies. The government of Pakistan under took program of liberal economic reforms including liberalization, privatization, and deregulation to bring the economy into a fully market-oriented system. Foreign investment is generally subject to the same rules as domestic investment, with the exception of certain sensitive areas such as defense production, banking, and broadcasting. However, the new Investment Policy provides equal investment norm opportunities for both domestic and foreign investors.
In recent years, the transformation of the speech of macroeconomic stability versus growth to stable growth due to high rates of inflation is an impediment to sustained growth. Then turned the discussion about the effectiveness of monetary policy in controlling inflation. Money is not neutral, at least in the short and medium term, and it can generate inflation with a slowing, the central bank has no mechanism to exercise complete control over inflation. In the past two decades, have experienced the phenomenon of infection and the liquidity crisis in all parts of the world, raising the specter of another Great Depression. Experience points to the wrong accounts, the monetary authorities in determining the role of money and its impact on the real economy. The question is how cans a country to do well otherwise the land itself in a financial crisis? The answer lies in people's expectations of self and the formation of a fallacy on the part of policy makers. Expectations about the future play an important role in growth (GDP) of investment and GDP. Emerging economies facing increased import bills due to the liberalization of trade and fluctuations in commodity prices and a shortage of food grains.
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THESIS Low productivity, shortage of energy, and perfect markets, and mismanagement of the current financial represents another challenge for the agenda of the central bank to price stability. In general, and central bank governors of the three options available to achieve stable inflation rate, which can be contribute to economic growth.
First, the central bank can adopt discretionary monetary policy without any framework a policy which simply fails to answer the questions that a central bank has to confront in light of an unstable money demand function. Alternatively, the central bank can control the exchange rate a policy that relies heavily on the policies of central banks in import originating countries, besides requiring strong financial and economic conditions. Second, the central bank can opt for a rulebased monetary policy, which targets income instead of money or prices. Third, a central bank may choose to target inflation explicitly as enemy number one 2 by making a transparent conditional forecast to make it accountable. A single choice or even a blend of all three is not considered the best policy for all countries, all time periods, or all types of environment. There is no such thing as a single, ideal monetary policy. It varies from country to country and with changing conditions. Each country needs a monetary policy that is robust, along with a conducive set of institutions, and commitment to fiscal responsibility for achieving the objective of price stability.
The inflation rate in Pakistan was reportedly the last to 11.55% in September 2011. From 2003 to 2010, average inflation rate in Pakistan is 10.15%, reaching a historical high of 25.33% in August 2008 and a record low of 1.41% in July of 2003. Inflation rate refers to a general rise in prices measured against a standard level of purchasing power. Most popular measures of inflation are the CPI which measures consumer prices, and GDP deflator, which measures inflation in the economy as a whole.
Inflation is the increase in prices of goods and services in an economy over a period of time. When the general price level rises, each functional unit of currency buys less goods and services, therefore, inflation is a decline in real value of money - a loss of purchasing power in the internal medium of exchange, which is the unit account in a monetary economy. Inflation is a key indicator of a country and provides important insight for the Economy and the police states that
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THESIS sound macroeconomic govern it. A stable inflation not only provides a nurturing environment for economic growth, but also uplifts the poor citizens with fixed incomes who are most vulnerable in society.
For a developing country like Pakistan, inflation needs to be stabilized in order to ensure sustainable growth as well as macroeconomic stability. Both empirical and theoretical studies demonstrate that there is a strong link between inflation and output (unemployment). Very high levels of inflation as well as very low levels of inflation are equally damaging for an economy. Both extremes arrest growth prospects, impose economic suffering on the population, because inefficient allocation of resources strangely hurt the poor and fixed income groups, create uncertainty throughout the economy and destabilize macroeconomic policies.
High inflation always burdens the poor and fixed income groups more than the rich since they are not able to protect themselves against the costs attached to inflation, nor able to enclose against the risks that inflation brings with it. In contrast, low or falling inflation can also have a negative impact on growth through several different factors. For instance, falling asset prices can constrain collateralized lending; the negative wealth effect can slow down demand; and borrowers are worse off since the real rates have turned against them.
The government needs to be careful about inflation, and thus has taken various steps to release pressure on the demand and boost the supply of commodities on the other. To ease demand pressures, and the State Bank of Pakistan (SBP) consistently emphasized monetary policy over the past three years, and even more so in the current fiscal year, in time to boost the supply, the government eased its import permits imports of several essential items so that there is a steady flow in the supply of these important commodities. In addition, the Government increased the imports of commodities such as wheat, pulses and sugar to complement the efforts of the private sector. In order to provide relief to the common man, and the government also increased the volume of operations for the company stores complain that provides basic commodities such as wheat flour, sugar, pulses and cooking oil / ghee at less than market prices.
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THESIS The Government stance remains steadfast, in that its policy objective is to ensure high growth while keeping inflation in check. Growth, on one hand, creates more jobs and increases incomes, directly contributing in reducing poverty. On the other hand, the associated higher inflation tends to worsen income distribution by hitting the low income groups the hardest, thus further reducing their purchasing power and perpetuating poverty.
The tradeoff between the two has to be dealt with the utmost care, which the Government is fully aware of and has taken several initiatives that seek to achieve a high rate of economic growth, lower unemployment and reduce the rate of inflation.
Historically, Pakistan is accustomed to lower inflation and thus has less tolerance towards higher double digit inflation. In this backdrop persistence of high double digit inflation for third year in a row has become intolerable and the government is pursuing combination of several policy measures such as the control of the budget deficit through appropriate fiscal and monetary policies, the improvement of agricultural productivity, the fostering of investment to stimulate output and the constant vigilance on the market situation to ensure the adequate availability of consumer goods to the common man at a reasonable price to bring inflation down to a tolerable and sustainable level.
In 2010-11 is the most eventful year for global inflation. Inflation poses a serious threat to microeconomic stability in all parts of the world. What is most disturbing in that the recent rise in inflation over the coming inflation in the food prices to the detriment of the state of poverty. According to ADB study, a 10% rise in food inflation is likely to deteriorate poverty situation by 2.7% points. Therefore, the recent strategy of containing inflation aims at alleviating poverty on the one hand and safeguard the average consumer against the hardships of rising prices on the other.
Saw the beginning of the year 2010-11 in Pakistan, a number of unfavorable factors affecting supply and demand situation, creating an imbalance in the economy. Massive floods swept five of the country and caused significant damage to livestock, crops and infrastructure, which led to a sharp acceleration in commodity prices and the rise in the rate of inflation. Necessitated the
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THESIS sensitive shortage of consumer goods imports in the high cost of large landed. While on the production front and imported inflation through traffic through the impact of rising oil prices and thus raise the cost of cargo transportation and production of materials and a significant increase in all consumer items or services. Influenced some of the structural problems of power outages and weaknesses in supply chains in the sectors of production and performance of the real added another factor pushing this trend to rising prices in general.
World prices are also adding fuel to the fire with the high prices of crude oil and commodities rose at a pace not seen since July 2010.Exacerbated the problem has escalated in Pakistan and all the price indices of international prices at a tremendous rate. Tend inflationary forces in many countries to become more aggressive and anxiety caused to the government and people alike. Tracked inflation around the world in the movement of world oil prices through the impact of energy prices and lagged affects on prices and other commodities. And continued improvement in global economic growth increases the demand for oil and grain in emerging market economies. The two countries are generally protected from the global commodity price movement, such as India and China for high rates of inflation, in recent times. Empirical literature on inflation growth nexus is divided into two main strands. One strand of literature has found negative and significant relationship between inflation and economic growth (Fisher, 1993; Barro, 1995; Bullard and Keating, 1995; Malla, 1997; Bruno and Easterly, 1998 and Faria and Carneiro, 2001) while other has confirmed positive and significant association between inflation and economic growth (Lucas, 1973; Mallik and Chowdhury, 2001 and Gillman and Nakov, 2004). These strands of literature highlight the possibility of non-linear relationship between inflation and economic growth. Several recent empirical studies have explored that whether the relationship between inflation and economic growth is in fact nonlinear. They are trying to support the hypothesis that low and stable inflation promotes economic growth and vice versa. Fischer (1993) explored this possibility and noted the existence of nonlinear relationship between inflation and economic growth. He found that there is positive association between inflation and economic growth at low rate of inflation, and a negative one as inflation rose.
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THESIS In this situation, various empirical studies are conducted. Sarel (1996) found that before 1970s inflation rates were modest in most countries and empirical studies during this period show the evidence of a positive relationship between inflation and economic while after 1970s inflation rates started to be high and a negative relationship between these variables, beyond that time period, was observed. Bruno and Easterly (1998) examine the determinants of economic growth using annual CPI inflation of 26 countries which experienced inflation crises during the period between 1961 and 1992. Their empirical analysis predicts that inflation rate of 40% and over is considered as the threshold level of inflation.
Pakistan's economy has lost significant energy in the past few years. Decline of the economic growth along with high inflation and low investment are the main problems of the economy of Pakistan increased the growth rate of real GDP fell to 1.2% in 2008 to 2009 from 9% in 200505. Investment is a key determinant of growth and volatility, reflecting the intensification of economic activities. The total investment declined from 22.5% of GDP in 2006-07 to 19.7% of GDP in private investment was slow and 2008-2009 since 2004-05 and persistently ratio to GDP has declined from 15.7% in 2004-2005 to 13.2% in 2008-2009. Rate of inflation, as measured by the Consumer Price Index (CPI), rose to 22.3% in 2008-2009 to an increase of 10.3% compared with (the Republican Party, 2010).
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THESIS
2.2 LITERATURE REVIEW:

Due to inflation the prices of goods and commodities increases. If there is rise in prices of goods and commodities then there is difficulty for Pakistan government to maintain the economic growth of Pakistan. So Pakistan government should control the inflation to maintain the economic growth of Pakistan. Inflation also devaluate the currency of Pakistan. If there is let down the currency of Pakistan the foreign debts routinely rise because government tale loans from other countries. According to Bruno (1995:38) persistent inflation is likely to be similar to burning once you get the tradition, it is very thorny to run off a deterioration compulsion. According to Gillman et al. (2002), threw on the data team from the Organization for Economic Cooperation and Development (OECD) and Asia-Pacific Economic Cooperation (APEC) countries, we note that reducing high inflation and average numbers to restrict the number one has a positive impact on expanding mention of the countries of the Organization for Economic Cooperation and Development, and to a degree The simplest of the APEC countries. Cohens (1993) the relationship between investment and external arrears from emerging countries for the year 1980 and study demonstrate that there is slight impact in the level of the stock of debt on investment. Different authors, the real trend of the net effect of transfer of the project. The study also reveals that the actual service of the debt crowded out expenses. In 1982-1989 Perasso (1992) using data from twenty middle-income severely indebted countries explored the relationship between foreign debts and economic growth. The study shows that appropriate within strategy have stronger blow on increasing investment and growth in highly indebted countries than decreasing debt-servicing responsibility. Sawada (1994) used yearly time series data for illustration period from 1955-1990 has shown that deeply indebted countries have debt beetle difficulties. Since their present external debts are above the anticipated present value of the potential expands. Was found to export and modify the plan and the impact of FDI on the rate of regular growth for the period 1970-1985 for a slice of 46 countries as well as taste secondary, from countries considered to continue to export-oriented strategy to be positive (Balasubramanyam et.al, 1996), and important, but is significantly negative in some cases, a subset of the following countries within the strategy-oriented. Accordingly (Sanchez Robles, 1998) discovered the relationship
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THESIS between the municipality experientially communication and monetary expansion in Latin America in the period 1970-1985. Also found an active and blow it should be noted foreign direct investment on economic growth for the countries of this region. Iyoha and Milton (1999) examine the relationship between exterior debt and financial augmentation for Sub-Saharan countries during the period 1970-1994. The study shows that external debt has unfavorably consequence investment. The study also summated out that lessening in debt hoard would lead to improvement in investment and economic growth. The authors worried that obligation of these countries should be absolved to stimulate economic growth. Karagl (2002) dissected rapport between economic growth and external debt overhaul for turkey during 1956-1996. The author used multivariate co-integration procedures. The study shows that there survives an unenthusiastic relationship between external and economic growth in the long run. Granger causality check consequences explained a uni-direction causality running from debt service to economic growth. Abdelmawla and Mohammed (2005) examine the impact of external debt on economic growth during 1978-2001 from Sudan. Study reveals that external debt and inflation rates, which negatively affected the economic performance of the country. Study also shows that the export precedes, and significantly positive effect on economic growth.
Khan and Senhadji (2001) examined the price rises and growth association moderately for industrial and developing countries. The authors reassess the topic of the subsistence of Threshold effects in relationship between inflation and growth, using econometric techniques originally developed by Chan and Tsay (1998) and Hansen (1999, 2000). They used the data set for 140 countries from 1960 to 1998. Their results strongly proposed the existence of doorstep away from which inflation applies a pessimistic effect on growth. Inflation level below the doorstep level has no effect on the expansion, while inflation velocities over the threshold have a historic negative effect on growth.
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THESIS Sweidan (2004) choose whether the connection between inflation and growth, and the financial and structural separation or not this juncture of the Jordanian economy between 1970 and 2003. He considers that this relative tend to be positive and significant than the rate of inflation less than 2% and the impact of structural division established the rate of inflation equals 2%. Behind this inflation affect the entry level of economic growth negatively.
Mubarak (2005) close to the edge of the plane to Pakistan annually using inflation data for the period between 1973 and 2000. Is also involved Granger causality test on the verge of providing representation, and finally, the appropriate sensitivity analysis of the model? Appreciation to the edge of the form indicates that the inflation rate exceeded 9% is harmful to economic growth in Pakistan. In this rotation and advanced to the inflation rate below the level of guessed from the 9% is favorable for economic growth. Moreover, analysis performed by the power of the form doorsill sympathy also achieved the same level of the entrance of inflation. Hussein (2005) estimates the level of the entrance of inflation in Pakistan using annual data for the period 1973-2005. Through the use of econometric model method to estimate the impact of the threshold, and suggests that the aim of inflation beyond the range of 4-6% would be a deterrent to economic growth admitted that he had the rank of the threshold of inflation for Pakistan. These results are in sharp contrast with answers to Mubarak (2005), where the threshold level of inflation for Pakistan at 9%.According to him, to achieve economic growth prolongable, must be a decline in inflation in a range between 4% and 6%.
Has considered many of the studies on the subject of tax revenues and customs duties were missing in the review of literature. However, the choices of most of the relevant papers of the famous and important review of the literature are included many of the papers recently, and the latest and authentic and studies. Anwar and Chaudhry [33] tested the hypothesis that the flow of foreign capital in general and the strength of an acceleration in economic growth and provide additional resources to complement domestic savings and increase overall productivity, which involve the transfer of real resources so that they can the borrower of the momentum for economic development and improve the growth and well-being.
24
THESIS Maingot and Mitchell [34] stated that international tax havens help depositors steal taxes and get away with black money. Tax havens support parallel black economies providing safe havens for the black money. Maingot further propounded that punitive measures against safe havens like Switzerland, Monaco, Guernsey-Gibraltar may be put in place internationally. Kamal [36] tried to estimate, which lies under the ground, and the economy of tax evasion in Pakistan use the methods of monetary, financial and work in the market economy to measure the ground below. Took over in 1973 as a data tag on the bench for the supply of money until 2002, using the critical approach. The study shows that 29 years of each of the underground economy and tax evasion has increased 1.83% as a percentage of gross domestic products. Baunsgaard and Ken [38]. The study that most developing countries and emerging markets is heavily dependent on revenues from trade taxes for a generation of public finance, to develop a budget annually to the economy further trade liberalization through the reduction of tariff rates, and bring more openness in the economy immediately reduce the total amount of revenue collected. However, if the development of alternative sources of income such as value-added tax and sales tax, taxes, goods less developed countries will not be able to bridge the gap in income. Slaughter [37] while discussing abolition of the tariff phase out industrial goods, said that the gains achieved in the flow of tax revenues and compete internationally by going to areas where they have comparative advantage in trade and even outside the weight loss of the initial tax on trade and tariff revenues when be reduced reliance on trade taxes and tariffs, and in the long term. Stoneman (1975) strongly criticized Weisskopf (1972) and Papanek (1973) is sufficient for modeling. In this study, but biased, or used samples of the country is incomplete, has been that choice is good for statistics, and shortcomings in the statistics themselves. Study the development of a simple regression model to test the effect of foreign capital, especially foreign direct investment on economic growth rates in 22 poor countries. The author estimates the model using the five-year periods (1948, 1953, 1958.1963, and 1968) data for all countries and puts the hypothesis that the flow of foreign capital may gradually raise the ratio of capital to output. Study results support the hypothesis, but suggest that foreign direct investment is associated with structural effects, such as export promotion, and changes in the ratio of capital to
25
THESIS output, and changes in income distribution, and motivate teams to various sectors, etc., which delay the growth. Therefore, the author includes net direct investment, and net foreign inflows, stock of foreign direct investment separately in the growth equation. Mosely (1980) criticizes previous work on aid, savings, and growth on the ground that none of the estimated equations provide any kind of structure behind, while the independent variables and the subsidiary. Until then, the existence of long periods of time between the commitment of aid, and OLS is not appropriate if the variable contains the independent variables, which are selfprocess under study, rather than to determine extraneously. Therefore, the way the second stage is the appropriate boxes for this model. Author estimates his model for the poorest 30 countries in the years 1969-1977 and finds that the relationship between aid and growth in these countries is still positive, but is an important and positive to the United Kingdom to assist countries and negative but small help of French and Scandinavian countries. Zaidi (1985) addresses the issue of debt-servicing capacity of developing countries in the Trial. Some country specific factor such as political stability, rate of return on capital, exchange rates and financial policies and business to be one of the most important factors while others address the problem of external debt of least developed countries. Internal study, as well as external factors, the underlying cause of the high debt service burden of the least developed Shabbir and Mahmood (1992) study the impact of external financial flows such as foreign private investment and aid on economic growth and domestic savings in Pakistan during the period from 1959-1960 to 1987-1988. Authors use two-stage least square method to estimate the simultaneous equations. The main conclusion of this study is that the net foreign private investment and disbursement of grants and foreign loans have a positive effect on the rate of real growth.
Khan and Rahim (1993) study the impact of changes in annual net revenues of economic assistance to the changes in two of the indicators of economic development; domestic savings and economic growth of Pakistan. Regression analysis includes OLS using the sample years 1960-1988.Grant aid also exhibits a positive effect on economic growth after one year of actual expenditures, but its estimated coefficient is insignificant.
26
THESIS Kamal (2001) explains the accumulation of debt and its effects on growth and poverty in Pakistan. The author shows that the accumulation of debt and debt service has a negative impact on the poor. The study shows that in spite of the burden of debt as a percentage of gross domestic products of Pakistan to exceed all the countries of South Asia, yet it is still not as high as to qualify for debt cancellation. This means that Pakistan has the ability to service debt.
Kamal (1997) estimates the savings rate against foreign capital flows side by side with others of different variables that affect the behavior of savings. The study found that it had been completely foreign capital inflows to finance consumption in Pakistan. As well, resulting in the increase in foreign capital in reducing the rate of savings of the same size and foreign aid may have contributed to the growth of almost anything.
Siddiqui and Malik (2002) estimate the direct impact on the debt on the rate of GDP growth and disagree that the accrual of debt and its growth relationship is not linear: up to a certain level of positive impact beyond the threshold of the relationship turns negative. Study reports mixed evidence regarding the impact of the burden of debt on economic growth. While the accumulation of debt in other countries in South Asia so far has not had a negative effect on the rate of growth, and the accumulation of debt in the case of Pakistan, resulting in low growth. Mohey-ud-din (2006) analyzes the impact of the foreign capital inflow on GDP Growth in Pakistan during 1975-2004. He concludes that the foreign capital may be helpful in boosting economic growth only under the presence of suitable monetary, fiscal and the trade policies. Major concern of the policies should be on the inflow of FDI and other form of foreign private capital, while the inflow official aid, loans, grants and debts should be minimized.
Khondoker (2007) conducted a study to identify the factors, which determine the FDI inflows to developing countries and also to investigate the correlation between FDI and economic growth. This study used panel data of 60 low-income countries for the period of 2003, 2004 and 2005. Results indicate that developing countries can attract more FDI if they have high GDP and growth rate, investment friendly policies and well established communication system.
27
THESIS Basu, Chakraborty and Reagle (2003) study a panel of 23 developing countries from Asia, Africa, Europe and Latin America, and find the causal relationship between GDP growth and FDI to run both ways in more open economies, and in only one directionfrom GDP growth to FDIin more closed economies. Trevino and Upadhyaya (2003) find a comparable result, based on their study of five developing countries in Asia, that the positive impact of FDI on economic growth is greater in more open economies. Moosa and Cardack (2006) examined The Determinants of FDI. They used cross-sectional data in this study and applied extreme bound analysis of 136 countries for the period of 1998 to 2000. The variables used in this study were real GDP, growth rate of GDP, export as a percentage of GDP, telephone lines, commercial energy use, domestic gross fixed capital formation, students in tertiary education as a percentage of total population and country risk. They explored that countries having large economies, high degree of trade openness and low country risk can attract ore FDI. They also found that real GDP, growth rate, energy consumption, domestic gross fixed capital formation etc. insignificantly boost up FDI inflows.
Shah and Ahmed (2004) conducted a research by using time series data for the period of 1961 to 2000. They found that long term association have been existing between FDI flows and factors including political stability, market size, capital cost, transport and communication expenditures in Pakistan. Campos and Kinoshita (2003) studys used 25 transition economies for the period of 1990 to 1998. They concluded that in these countries, FDI is affected by market size, economy clusters, low labor cost and availability of natural resources. Results also reveal that sound institutions, trade openness and low degree of restrictions to FDI inflows are highly significant. Holland et al. (2000) pointed out that market size and growth prospective are the important determinants of FDI.
28
THESIS Fry (1997) studies the impact of alternative deficit financing strategies on economic growth for sixty six low-income countries and emerging markets for the period of 1979-1993. The study shows that market based domestic debt issuance is the least cost method of financing the budget deficit as contrasting with external borrowing. All of these methods reduce growth, domestic savings and increase inflation.
Singh (1999) explores the relationship between domestic debt and economic growth in India by applying co integration technique and Granger causality test for the period of 1959-95. The author considers two theoretical views of domestic debt and economic growth one is traditional view of long-run negative impacts of domestic debt on economic growth and second is Ricardian equivalence hypothesis that shows neutrality of domestic debt to growth. The results of the Engle-Granger co integration test indicate that the domestic debt and economic growth and not co-integrated. The study supports the Ricardian correspondence hypothesis between domestic debt and growth in India.
Kemal (2001) explains the debt accumulation and its implications for growth and poverty in Pakistan. The study shows that debt accumulation (domestic and external) and debt servicing affects the poor adversely. The findings of the study illustrate that even though debt burden as a percentage of GDP of Pakistan exceeds that of all South Asian countries but it is not still so high as to go for debt write off. This means that Pakistan has the capacity to service the debt.
Uzochukwu (2003) investigates the quantitative effects of public debt (domestic and external) and economic growth on poverty in Nigeria by applying the per-capita income approach using annual data of 1970 to 2002. The study uses growth and debt variables and suggests that these variables have played very vital role towards poverty acceleration in Nigeria.
Schclarek (2004) observes the relationship between gross government debt and per capita GDP growth in developed countries. The results of the paper show that there is no strong evidence of a statistically significant relationship between gross government debt and per capita GDP growth for a sample of 24 industrial countries with data from 1970 to 2002.
29
THESIS Abbas and Christensen (2007) highlight the impact of domestic debt on economic growth for ninety three low-income countries from the period of 1975-2004 by applying Granger Causality Regression model. The analysis shows that moderate levels of marketable domestic debt as a percentage of GDP have significant positive, non-linear impacts on economic growth, but debt levels exceeding 35% of total bank deposits have negative impact on economic growth. Maana et al (2008) evaluate the economic impact of domestic debt on Kenyas economy. Authors examine the impacts of domestic debt on private sector lending by applying ordinary least square technique using annual data over the period 1996 to 2007.
The study concluded that domestic debt does not crowd out lending to the private sector in Kenya during the period due to a significant level of financial development in Kenya. The study examines also the effects of domestic debt on real output growth using Barro modify the regression model. The results indicate that the increase in domestic public debt have a positive effect but little economic growth during this period.
Muhdi and Sasaki (2009) examine the role of external debt and domestic macro-economic situation in Indonesia authors applied the ordinary least square (OLS) estimation using annual data for the period from 1991 to 2006. The study shows that the trend of rising foreign debt became a central policy to overcome the deficit. This has created a positive impact on both investment and economic growth. But aside from these positive effects and the policy of devaluation of local currency. On the contrary, the rising trend of domestic debt to encourage private investment because of the crowding-out effect, which reduces the capital stock and total production. Perasso (1992) examined the using data from middle-income countries heavily indebted to the twenty periods of 1982-1989 the relationship between economic growth and foreign debt. The study indicates that appropriate internal policies have a stronger effect on increasing investment
and growth in highly indebted countries to reduce the debt service obligation.
30
THESIS Cohen (1993) investigates the relationship between external debt and investment in developing countries for the year 1980. The study shows that there is little effect of the level of the stock of debt on investment. The author reported that the actual flow of remittances affect net investment. The study also reveals that the actual service of the debt "busy" to investment. Cunningham (1993) investigates the relationship between debt and economic growth for sixteen countries for the period 1971-2007. The study shows that the growth of debt in a country has a negative effect on economic growth. He also said that when he was a great country to foreigners and this negatively impact the productivity of capital and labor. Chowdhury (1994) investigates the relationship between debt and economic growth of Bangladesh, Indonesia, Malaysia, the Philippines, South Korea, Sri Lanka and Thailand for the period from 1970-1988. Explore them that the external debt leads to mismanagement of the exchange rate. For further study states that external debt does not affect the rate of growth of gross national product.
Tamaschke and Metwally (1994) worked two stage least square (2SLS), and less regular Square (OLS) method to investigate the relationship between debt service and increased flows of capital and economic growth in Algeria, Morocco and Egypt during 1972-2002. Study results show that capital flows have a significant impact on the growth of the relationship of debt.
Sawada (1994) used time series of annual data for the period 1955-1990 that the sample of heavily indebted countries with debt problems accumulated. Since the current external debt is above the current value of the expected gains in the future.
Badawi et al. (1996) use cross-section of data 99 countries to investigate the relationship also investigated the same relationship of any external debt and economic growth. The book is of the view that the current debt flows as a percentage of GDP, and the accumulation of past debt service ratio debt has impacted negatively on economic growth.
31
THESIS Amoateng Amoako Addo (1996) studied using data collected in the form of time series and cross-sectional relationship between external debt service, economic growth and exports to 35 countries in Africa during 1971-1990. The study shows that there is a one-way causal relationship between the positive and the service of foreign debt and GDP growth after the elimination of export revenues.
Fuso (1996) study the relationship between economic growth and foreign debt for a sample of sub-Saharan African countries for the period 1970-1986. The study reveals that the average height of religion, a country facing some of the decline in gross domestic product annually.
Deshpande (1997) investigation the relationship between external debt and investment, 13 countries are heavily indebted to the period 1971-1991 using OLS. The study shows that there is a negative relationship between external debt and investment. Olgun et al. (1998) and works 2SLS 3SLS methods of investigating the relationship between capital flows and foreign equity, debt, investment and economic growth during 1965-1997 for Turkey. The study shows that there is a relationship in two directions between the debt and debt service. The book pointed out that debt service does not affect economic growth.
Iyoha and Milton (1999) investigate the relationship between external debt and economic growth for the countries of sub-Saharan Africa during the period 1970-1994. The study indicates that external debt has a negative effect on investment. The study also noted that the reduction of debt would lead to an improvement in investment and economic growth. The author stressed the need to forgive the debt of these countries to stimulate economic growth.
Fuso (1999) has been used production function to investigate the effect of increasing external debt on economic growth in sub-Saharan Africa in the period 1990 -1980. The study reveals that there is a negative relationship between religion and economic growth. The study also shows that the negative impact of poor instead of debt of investment level.
32
THESIS Karagol (2002) examined the relationship between economic growth and external debt service to Turkey during 1956-1996. The author used joint multivariate integration techniques. The study shows that there is a negative relationship between the foreign and economic growth in the long term. The results of the Granger causality test of a unidirectional causality running from debt service to economic growth.
Abdelmawla Mohammed (2005) investigates that the impact of external debt on economic growth during 1978-2001 from Sudan. The study reveals that the foreign debt and inflation, which negatively impacted on the economic performance of the country. The study also shows that export earnings have a significant positive impact on economic growth. Chowdhury (1998) investigates whether Pakistan, which will accumulate a heavy burden of foreign debt if the current trend is to continue borrowing. The author evaluated the impact of trade and savings on foreign debt. This study discloses that if Pakistan has to reduce the debt burden of trade policy is to provide more favorable policies. Ahmad (1997) used three-gap model to explore the problem of external debt of Pakistan. Writer suggested that if Pakistan has to reduce the load of debt which should focus on fiscal policy measures. These can be measures of fiscal policy changes in the tax rate and government consumption expenditure and public expenditure.
Shabbir and Mahmood (1992) study the impact of foreign financial flows such as foreign private investment and aid on economic growth and domestic savings in Pakistan during the period from 1959-1960 to 1987-1988. Authors use two-stage least square method to estimate the simultaneous equations. The main conclusion of this study is that the net foreign private investment and disbursement of grants and foreign loans have a positive impact on the rate of real growth of GDP in Pakistan and that foreign financial flows may discourage local public and / or the behavior of private savings and resource mobilization efforts.
33
THESIS Khan and Rahim (1993) study the impact of changes in annual net revenues of economic assistance to the changes in two of the indicators of economic development; domestic savings and economic growth of Pakistan. Regression analysis includes OLS using the sample years 1960-1988. Regression equations estimated to provide savings for the local negative correlation coefficients between foreign aid and local efforts to mobilize resources.
Kamal (1997) estimates the savings rate against foreign capital flows side by side with others of different variables that affect the behavior of savings. The study found that it had been completely foreign capital inflows to finance consumption in Pakistan. As well, resulting in the increase in foreign capital in reducing the rate of savings of the same size and foreign aid may have contributed to the growth of anything.
Kamal (2001) explains the accumulation of debt and its effects on growth and poverty in Pakistan. The author shows that the accumulation of debt and debt service has a negative impact on the poor. The study shows that in spite of the burden of debt as a percentage of gross domestic products of Pakistan to exceed all the countries of South Asia, yet it is still not as high as to qualify for debt cancellation. This means that Pakistan has the ability to service debt.
Mohiuddin Guessoum (2006) and analyzes the impact of the flow of foreign capital to GDP growth in Pakistan during 1975-2004. And concludes that foreign capital may be useful in promoting economic growth only in the presence of appropriate monetary, fiscal and trade policies. Should be the primary concern of policies that are on the flow of foreign direct investment and other forms of foreign private capital, when it should reduce the flow of official aid, loans, grants and loans.
Demure [31] reported that the least developed countries are still widespread in the further liberalization of tariffs as low would reduce the bias against tradable goods and the transfer of productive resources in the export sectors in the ring to give impetus to the economy. Kamal [32] that analyzed in the global village or any country's economy cannot succeed by following the policies of isolationism and the remaining being completely closed economy. And Anwar Chaudhry [33] tested the hypothesis that the flow of foreign capital in general, and was an
34
THESIS accelerating force for economic growth and provide additional resources to complement domestic savings and increase overall productivity, which involve the transfer of real resources so that they can the borrower of the energy of economic growth and improve well-being. Maingot and Mitchell [34] reported that the international tax havens help depositors theft taxes and get away with black money. Tax havens support the economies of parallel black to provide safe havens for black money. Maingot raised that may be put punitive measures against the safe havens such as Switzerland, Monaco, Guernsey and Gibraltar in place internationally. Kamal [36] tried to estimate, and the underground economy and tax evasion in Pakistan. Used monetary, financial and working methods in the market to measure the underground economy. Took over in 1973 as a bench mark data on money supply until the year 2002 using the critical approach. The study showed that 29 years for each of the underground economy and tax evasion has increased 1.83% as a percentage of gross domestic products.
2.3 THEORETICAL FRAMEWORK:

To apply the study various dependent, independent and moderating variables will be defined for theoretical framework. The independent variable is inflation, foreign debts and foreign direct investment and economic growth of Pakistan is a dependent variable. The reason why these two variables have been chosen is to see the relationship between them. It is evident from the existing literature that there are identified variables which influence the economic growth of Pakistan. Therefore inflation, foreign debts and foreign direct investment should be measured through the economic growth of Pakistan. If there is decline in inflation, reduction in foreign debts and increase in foreign direct investment then economic growth rate of Pakistan will increase. In the study the multiple regression models is used to verify the basic hypothesis. 2.3.1 INFLATION: The rise in prices of products and commodities called inflation. Inflation can be sourced by international lending and nationwide debts. When government borrows money, they have to compact with consciousness, which in the end cause prices to rise as a way of keeping up with their debts. A profound dive of the exchange rate can also result in inflation, as governments will have to covenant with differences in the import/export level.
35
THESIS 2.3.2 FOREIGN DEBTS: Impact of foreign debt on growth has been discovered in the condition of Pakistan for the period 1972-2005. The data are taken from International Financial Statistics, World Bank, Pakistan Economic Survey (various issues), and World Development Indicators (WDI 2005).
2.3.3 FOREIGN DIRECT INVESTMENT: The time outline for the study of Foreign Direct Investment (FDI) is 1990-2006, based on the grounds that 'Pakistan faces beg receiving significant amounts of FDI 1990s. The hypothetical model is that' used to examine the interaction of FDI and Economic Growth is based Following on the Production function.
2.4THEORETICAL FRAMEWORK MODEL:
Foreign debts
Foreign direct investment
Economic growth of Pakistan
Inflation
Economic growth of Pakistan= f (foreign debts, foreign direct investment, inflation)
36
THESIS
2.5 METHODOLOGY/DATA:
In this study, annual time series data from 1970 to 2006 data is taken from World Development Indicator (WDI), Pakistan Economic Survey (various issues) of the Ministry of Finance, various Annual Reports of the State Bank of Pakistan and World Bank. In this model the quantitative research method will be used. Time series data is used to find the impacts of foreign direct investment, foreign debts and inflation on economic growth of Pakistan.
2.6 ANALYSIS:
The result of the study analysis is presented in this chapter. Descriptive analysis used to describe the data by using descriptive summary. Inferential analysis used to describe the relation between variables by checking the acceptance or rejection of hypothesis and to see the nature of relationship between variables. Data screening and preparation is focused on ensuring that the data contained the appropriate range of scores for all analyzed variables including the identification of possible outlines. I have used the secondary data so I collected the data from world development indicator (WDI). I used Spss in this research and apply different tests in this research. In this portion all the results with their interpretation were shown and being discussed.
37
THESIS 2.6.1 SCATTER PLOTS: Scatter plot or graph of two variables shows how the scores for an individual on one variable associates with his or her scores on the other variable. To check the overall picture for identifying the relationship between dependent and independent variable I will use scatter-plots. This matrix shows all the possible two dimension plots of the variables. Scatter plot will used to see the graphical picture of relationship between the dependent and independent variable. Lets discuss every plot or graph:
38
THESIS
In these graphs we check the relationship between inflation, foreign debts and foreign direct investment with economic growth of Pakistan. We observe that the relationship between inflation, foreign debts and economic growth of Pakistan is insignificant because its value is less than 0.05 which is 0.032 and 0.025 but the relationship between foreign direct investment (FDI) and economic growth of Pakistan is more significant because its value is 0.293 which is greater than 0.05. The flow of line from right to left in foreign direct investment (FDI) also shows the positive relationship. It means that if there is increase in foreign direct investment (FDI) than there is increase in economic growth of Pakistan but if there is increase in inflation and foreign debts than there is decrease in economic growth of Pakistan. 2.6.2CORRELATIONS: Correlation is used to check the mutual relationship among variables. I will use correlation to find
the relationship among variables as well as check the strength of the relationship of different variables. It will also show the direction of relationship between two variables.
For checking the relationship we will make two hypotheses: null (H0) and alternative (H1). We interpret the findings on the acceptance or rejection of the hypothesis. We used correlation matrix to check the mutual relationship of different variables. The hypothesis which we developed is given below:
39
THESIS
Correlations economic growth of Pakistan ( GDP growth (annual %) economic growth of Pakistan Pearson Correlation ( GDP growth (annual %) Sig. (2-tailed) N inflation Pearson Correlation Sig. (2-tailed) N foreign debts Pearson Correlation Sig. (2-tailed) N foreign direct investment Pearson Correlation Sig. (2-tailed) N **. Correlation is significant at the 0.01 level (2-tailed). 36 .045 .793 36 -.225 .188 36 -.080 .676 30 36 -.308 .067 36 .110 .562 30 36 .715
**
foreign direct inflation 1 .045 .793 36 1 foreign debts -.225 .188 36 -.308 .067 36 1 investment -.080 .676 30 .110 .562 30 .715
**
.000 30 1
.000 30 30
Our main objective is to find out the relationship between inflation, foreign debts, foreign direct investment (FDI) and economic growth of Pakistan. All these variables are scale; we would check the possibility for using Pearson Correlation. The assumptions of Pearson Correlation are as bellow:
The relationship between two variables should be linear The data on both the variables should be normally distributed (Scale Variable) The data on both the variable should be independent
In our case all the assumptions mentioned above are fulfilled so we would use Pearson Correlation test. The null hypothesis and alternative hypothesis using Pearson Correlation in our case are given as bellow:
40
THESIS H1: There is relationship between inflation and economic growth of Pakistan H0: There is no relationship between inflation and economic growth of Pakistan
H1: There is relationship between foreign debts and economic growth of Pakistan H0: There is no relationship between foreign debts and economic growth of Pakistan
H1: There is relationship between-n foreign direct investment and economic growth of Pakistan H0: There is no relationship between foreign direct investment and economic growth of Pakistan The foreign debts and foreign direct investment (FDI) are negatively correlated to the economic growth of Pakistan but inflation is positively correlated to the economic growth of Pakistan. The value of Pearson correlation test between inflation and economic growth of Pakistan is .045 and significance level is .793 which is greater than 0.05, the value of Pearson correlation test between foreign debts and economic growth of Pakistan is -.225 and significance level is .188 which is greater than 0.05 and the value of Pearson correlation test between foreign direct investment (FDI) and economic growth of Pakistan is -.080 and significance level is .676 which is greater than 0.05. From the above discussion we can say that the relationship between inflation, foreign debts and foreign direct investment (FDI) is significant and moderate. The value .045 of Pearson correlation tells that if we observed the inflation and economic growth of Pakistan 100 times than 4 times they will change, the value -.225 of Pearson correlation tells that if we observed the foreign debts and economic growth of Pakistan 100 times than -22 times they will change and the value -.080 of Pearson correlation tells that if we observed the foreign direct investment (FDI) and economic growth of Pakistan 100 times than -8 times.
41
THESIS 2.6.3REGRESSION: Regression is used to check the effect size of independent variable on dependent variable. Regression analysis is used to find the size of the effect of dependent variable independent variable that will occurs how much change in the dependent variable due to changes in independent variables using the regression equation for analysis, where I will control the value of F-test to check the best fit of the model. Also I will make them focus on the T value to control the level of importance of relationships for acceptance or rejection of our alternative hypothesis. I will focus on the value of R2 for the first level of the input variable Independent variable means that much to contribute to changing the value of the dependent variable. Since the objective of this study is to check the impact of inflation, foreign debts and foreign direct investment on economic growth of Pakistan.
The main cause of the study is to review / specify the collision of FDI on economic growth, in order to attain the desired aim, other independent variables which are assumed naturally to pressure the economic growth will be included in the model.
R2 =
Explained variation in debt and economic growth ________________________________________ Total variation in debt and economic growth r = R2
R2 = 1-(1-R2) (n-1\n-k)
Model Summary Adjusted R Model 1 R .559

a
Std. Error of the Estimate
R Square .312
Square .233
1.882
a. Predictors: (Constant), foreign direct investment, inflation, foreign debts
42
THESIS Explained variation/ (k 1) _____________________ Total variation/ (n k)
F=
R2 / (K 1) F = ______________ (1 R2) / (n k)
ANOVA Model 1 Regression Residual Total Sum of Squares 41.766 92.108 133.874 df
Mean Square 3 26 29 13.922 3.543
F 3.930
Sig. .019
a
a. Predictors: (Constant), foreign direct investment, inflation, foreign debts b. Dependent Variable: economic growth of Pakistan (GDP growth (annual %)
Coefficients
Standardized Unstandardized Coefficients Model 1 (Constant) inflation foreign debts foreign direct investment B 8.281 -.025 -1.730E-10 2.437E-9 Std. Error 1.470 .122 .000 .000 -.036 -.805 .500 Coefficients Beta t 5.635 -.207 -3.289 2.050 Sig. .000 .838 .003 .051
a. Dependent Variable: economic growth of Pakistan (GDP growth (annual %)
Necessary Statistics R2 = .312 F= 3.930 SigF = .019a
The affect of inflation, foreign debts and foreign direct investment on economic growth of Pakistan is shown by the values of the T-statistic. T-test is used to test the significance of the individual partial regression coefficients. The value of T-statistic of inflation and foreign debts is
43
THESIS less than 0 that is -.207 and -3.289 which is less significant and the value of T-statistic of foreign direct investment is 2.050 which is significant. The value of F is 3.930 and the value of R2 is .312. The value of coefficient of determination R2 shows that the correlation between the observed values is not fitted on 1% level of significance. If the value of R2 is near to 1 than it will be more fit value. The value of F-statistic is statistically significant is 3.930 which is less than 10 so the value of F-statistic is not correct or we can say that it is not acceptable. To find the impact inflation, foreign debts and foreign direct investment on economic growth of Pakistan the specified equation the following regression will take the form:
Y=0+1X1 +2X2+3X3+ Ei
Economic growth of Pakistan (GDP growth annual %) = 0 + 1(inflation)+ 2(foreign debts)+ 3(foreign direct investment)+ Ei Economic growth of Pakistan (GDP growth annual %) = 8.281+ (-.025) (inflation) + (-1.730E10) (foreign debts) + 2.437E-9(foreign direct investment) + 0 In this equation the independent variables show the partial regression coefficient represents the change in dependent variable, due to one unit change in independent variables where the Y is dependent variable. 0 is constant. 1, 2 and 3 are independent variable. Ei is the error term. If inflation is increased by 1% than economic growth of Pakistan would decrease by -.025, if foreign debts increase by 1% then economic growth of Pakistan would decrease by -1.730E-10 and if foreign direct investment increases by 1% then economic growth of Pakistan would increase by -1.730E-10. 2.6.4 CRONBACHS ALPHA:
Reliability Statistics Cronbach's Alpha .089 N of Items 3
Descriptive summary shows the overall picture of the three variables. The cronbachs alpha is .089 which is less than 0.70 so it is not reliable. It shows the statistical summary of three scale variables.
44
THESIS
2.7 CONCLUSION:
The study is to check the impact of inflation, foreign debts and foreign direct investment on economic growth of Pakistan. From the supported material and result of study it is concluded that inflation and foreign debts has negative impact and foreign direct investment has positive impact on economic growth of Pakistan. If government of Pakistan takes keen interest to recover the foreign debts and stable the inflation rate then the economic growth of Pakistan can be improved. There is only need of government attention. If government pays full awareness to foreign debts and inflation the economic growth of Pakistan can be improved. The economy of Pakistan has grown up by 6.5% since 2003 and the share of GDP in investment increase from 17% in 2001-02 to 20% in 2005-06 which shows positive sign for the economic growth of Pakistan.
2.8 RECOMMENDATIONS:
After finding the results I recommend that government should control inflation and it should recover all the foreign debts because these two variables badly effected to the economy of Pakistan. Government should promote the multinational companies for the foreign direct investment because it has positive impact on economic growth of Pakistan.
45
THESIS
2.9 REFERENCES:
Iyoha and Milton (1999) External debt and economic growth in sub-Saharan African Countries: An econometric study AERC Research Paper 90 African Economic Research Consortium, Nairobi. Abdelmawla and Mohamed (2005) The Impact of External Debts on Economic Growth: An Empirical Assessment of the Sudan: 1978-2001 Eastern Africa Social Science Research Review - Volume 21, Number 2, June 2005, pp. 53-66 Bruno, M. and W. Easterly (1996). Inflation and Growth: In Search of Stable Relationship. Federal Reserve Bank of St. Louis Review, Vol. 78, No.3. Fischer, S. (1993). The Role of Macroeconomic Factors in Growth. Journal of Monetary Economics, Vol.32: 485-512.
Gillman, M., M. Harris, and L. Matyas (2002). Inflation and Growth: Some Theory and Evidence. Berlin: 10th International Conference on Panel Data.
Sawada, Y. (1994) Are the heavily indebted countries solvent? Tests of inter temporal borrowing constraints, Journal of Development Economics, 45, pp. 325-337. Cohen, D. (1993). Low Investment and Large LDC Debt in the 1980s The American Economic Review Vol 83, pp 437-449 Perasso, Giancarlo (1992): Debt Reduction versus Appropriate Domestic Policies, Kyklos, Cilt 45, Say 4, pp. 457-467 Iyoha and Milton (1999) External debt and economic growth in sub-Saharan African Countries: An econometric study AERC Research Paper 90 African Economic Research Consortium, Nairobi. [16] Karagl (2002)
46
THESIS Sweidan, O. D. (2004), Does Inflation Harm Economic Growth in Jordan? An Econometric Analysis for the Period 1970-2000, International Journal of Applied Econometrics and Quantitative Studies, Vol.1, No. 2 Mubarik, Y. A. (2005), Inflation and Growth: An Estimate of the Threshold Level of Inflation in Pakistan, State Bank of Pakistan Research Bulletin, Vol. 1, No. 1 Hussain, M. (2005), Inflation and Growth: Estimation of Threshold Point for Pakistan, Pakistan Business Review, Vol. 7, No. 3 Khan, M.S, Senhadji, A.S. and Smith B.D, (2001), Inflation and Financial Depth,IMF Staff Paper. Kemal, A. R., (1997), Pakistan Foreign Debt: Perception and Reality, Pakistan Bankers, 7(2), 58-65. Kemal. A. R., (2001), Debt Accumulation and Its Implications for Growth and Poverty The Pakistan Development Review 40 (4), 263-281. Stoneman, C., (1975), Foreign Capital and Economic Growth. World Development, 3(1), 1126. Shabbir, T. and Mahmood, A., (1992), The Effects of Foreign Private Investment on Economic Growth in Pakistan, The Pakistan Development Review, 31 (4). Chowdhury, K. (1994) A structural analysis of external debt and economic growth: some
evidence from selected countries in Asia and the Pacific , Applied Economics 26, pp.1121- 1131.
Cohen, D. (1993). Low Investment and Large LDC Debt in the 1980s The American Economic Review Vol 83, pp 437-449 Campos NF, Kinoshita Y (2003). Why does FDI go where it goes? New evidence from the transition economies. IMF Working Paper, IMF Institute.
47
THESIS Cunningham (1993) The Effects of Debt Burden on Economic Growth in Highly Indebted Nations Journal of Economic Development, 18(1), 115-126 Iyoha and Milton (1999) External debt and economic growth in sub-Saharan African Countries: An econometric study AERC Research Paper 90 African Economic Research Consortium, Nairobi. Khan N. Z., and Rahim E. (1993) Foreign Aid, Domestic Saving and Economic Growth, 19601988. The Pakistan Development Review 32:4 11571167.
Siddiqui, R. and A. Malik (2002). Debt and Economic Growth in South Asia. The Pakistan Development Review, vol. 40 (4), pp. 677-688. Zaidi, I. M., (1985), Saving, Investment, fiscal deficits and the external indebtness of developing countries, World Development, 13 (5), 573-588. Basu, P., C. Chakraborty, and D. Reagle (2003) Liberalization, FDI, and Growth in Developing Countries: A Panel Cointegration Approach, Economic Inquiry, 41, pp. 510-516. Trevino, Len J. and K. P. Upadhyaya (2003) Foreign aid, FDI and economic growth: Evidence from Asian countries, Transnational Corporations, 12 (2), pp.119-135. Kemal.A.R (2001). Debt Accumulation and Its Implications for Growth and Poverty. The Pakistan Development Review, 40(4). Mosely, P., (1980), Aid Savings, and Growth Revisited, Oxford Bulletin of Economics and Statistics, 42 (2). Iyoha and Milton (1999) External debt and economic growth in sub-Saharan African Countries: An econometric study AERC Research Paper 90 African Economic ResearchConsortium, Nairobi.
48
THESIS Karagl (2002) The Causality Analysis of External Debt Service and GNP: The case of Turkey Central Bank Review 85(5) 1106-17
Maingot, A. P. and D. Mitchell (2002). Taxing Free Riders. Foreign Policy, No.132. 6-8. Fosu, A. K. (1999). The External Debt Burden and Economic Growth in the 1980s: Evidence from Sub-Saharan Africa. Canadian Journal of Development Studies, XX (2) Amoateng, Kofi. ve Amoako, Adu.B. (1996): Economic Growth, Export and External Debt Causality: The Case of African Countries, Applied Economics, Vol28, pp. 21-27. Khan, N.Z. and E. Rahim (1993) Foreign Aid, Domestic Savings and Economic Growth (Pakistan: 1960-1988)Pakistan Development Review. Islamabad: Pakistan Institute of Development Economics. 32 (4), 1157-67.
Chaudhary M. Aslam and S. Anwar (2001). Debt Laffer Curve for South Asian Countries. The Pakistan Development Review, Vol. 40(4) Part II. 705-720.
Sawada, Y. (1994) Are the heavily indebted countries solvent? Tests of inter temporal borrowing constraints, Journal of Development Economics, 45, pp. 325-337.
Uzochwkwus, Amakom (2003). Nigeria Public Debt and Economic Growth: An empirical Assessment of Effects on Poverty. African Institute for Applied Economics Enugu Nigeria.
Schclarek, A. (2004). Debt and Economic Growth in Developing Industrial Countries, mimeo, available on-line http://www.nek.lu.se/publications/workpap/Papers/WP05_34.pdf
Fry, M (1997). Emancipating the Banking System and Developing Markets for Government Debt. (London: Routledge)
49
THESIS Khondoker AM (2007). Determinants of Foreign Direct Investment and its Impact on Economic Growth in Developing Countries. Available at: http//www.mpra.ub.uni muenchen.de/9457/ MPRA Paper No. 9457, Posted 05, July 2008/20:27.
Singh, charan (1999). Domestic Debt and Economic Growth in India. Economic and Political Weekly, 34(23), 1445-1453. World development indicator (WDI) Economic survey of Pakistan, Government of Pakistan
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Supervised by: Prof. Habib Asghar

SUPERIOR UNIVERSITY, LAHORE

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Supervision: _______________ Date: ____________

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First of all I would like to thank my (

) who always guides me in every walk of my life.

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2.2 LITERATURE REVIEW:

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2.3 THEORETICAL FRAMEWORK:

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2.4THEORETICAL FRAMEWORK MODEL:

Foreign direct investment

Economic growth of Pakistan

Economic growth of Pakistan= f (foreign debts, foreign direct investment, inflation)

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Model Summary Adjusted R Model 1 R .559

Std. Error of the Estimate

a. Predictors: (Constant), foreign direct investment, inflation, foreign debts

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THESIS Explained variation/ (k 1) _____________________ Total variation/ (n k)

Mean Square 3 26 29 13.922 3.543

a. Dependent Variable: economic growth of Pakistan (GDP growth (annual %)

Necessary Statistics R2 = .312 F= 3.930 SigF = .019a

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Supervision: ___ Date: