The Conditional Promise of FDI: New Insights from South Asia’s Growth Experience

This paper investigates how Foreign Direct Investment (FDI) affects economic growth in five South Asian countries—Bangladesh, India, Pakistan, Sri Lanka, and Nepal—between 2019 and 2023. Although FDI is often seen as a key driver of development through capital investment, technology transfer, and improved management practices, its actual impact on economic growth in developing countries remains unclear. This study builds on the Absorptive-Capacity Hypothesis, which suggests that the benefits of FDI depend on how well a country can use the knowledge and resources that come with it. Using macroeconomic data from the World Bank, the study applies panel data techniques and lagged variables to understand the short-run effects of FDI, while also controlling for inflation and trade openness. The analysis begins with Ordinary Least Squares (OLS) regression and continues with Fixed Effects (FE) and Random Effects (RE) models to account for differences across countries. The results show that FDI, when lagged by one year, has a statistically significant negative effect on GDP growth, while trade openness supports growth and inflation reduces it. The Hausman test confirms that the Fixed Effects model is more appropriate, highlighting the importance of country-specific factors. These findings suggest that FDI on its own may not lead to growth unless countries improve their ability to absorb and benefit from it. The paper concludes that strong trade policies, inflation control, and investment in human capital are crucial for ensuring that FDI contributes to long-term economic development in South Asia.