IMPACT OF FOREIGN DIRECT INVESTMENT ON THE PROFITABILITY OF DOMESTIC FIRMS IN PAKISTAN

Abstract

This study investigates the impact of Foreign Direct Investment (FDI) on the profitability of domestic firms in Pakistan, using time series data spanning from 1996 to 2015. The research applies an autoregressive econometric model to analyze the relationship between FDI inflows and firm-level profitability, measured by Return on Assets (ROA). Stationarity of variables was tested using the Augmented Dickey-Fuller (ADF) test, revealing mixed orders of integration, thereby justifying the use of autoregressive methods. The analysis incorporated variables such as FDI, FDI per capita, and four lags of ROA as explanatory factors. Diagnostic checks, including the Q-statistic, LM test, Breusch-Pagan-Godfrey test for heteroskedasticity, Jarque-Bera test for normality, and the Cusum test for stability, confirmed the model’s robustness. Empirical results demonstrate a significant and positive relationship between FDI and the profitability of domestic firms, while FDI per capita also exhibited a positive influence. Interestingly, the lagged values of ROA revealed a negative relationship, indicating dynamic adjustments in profitability over time. The study concludes that enhanced FDI inflows lead to increased profitability of domestic firms through technology transfer, competition, and capital availability. It recommends that the Government of Pakistan implement investor-friendly policies to further attract FDI and support sustainable economic growth.