Discussion Paper

No. 2019-55 | November 07, 2019
Does foreign direct investment in financial services induce financial development? Lessons from emerging economies

Abstract

The authors employ panel Vector Error Correction Models (VECM) and cointegration framework to identify the existence and direction of the causal association between foreign direct investment (FDI) in financial services and financial development for 26 emerging economies for the period 2003–2015. Their results show that there exists a long-run cointegrating relationship between financial development and FDI in financial services after incorporating the extent of heterogeneity among emerging economies. The authors find long run unidirectional causality from financial development to financial services FDI. Using fully modified OLS (FMOLS) estimation, they estimate the long run elasticities between financial services FDI and financial development. Their  results show that financial development has a positive and significant impact on FDI in financial services, which implies that a country with well-developed financial markets tend to attract larger amounts of FDI in financial services.

JEL Classification:

G20, F23, C33

Assessment

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Links

Cite As

Jithin Podikkalathil and Suresh Babu Manalaya (2019). Does foreign direct investment in financial services induce financial development? Lessons from emerging economies. Economics Discussion Papers, No 2019-55, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2019-55


Comments and Questions


Anonymous - Invited Reader Comment
December 19, 2019 - 11:56

In this paper, the authors are trying to examine the relationship between foreign direct investment (FDI) in financial services and financial development for 26 emerging economies for the period 2003-2013. The authors found that there exist a long-run cointegration between FDI in financial services and financial development. It is also ...[more]

... reported in the study that financial development has a positive and significant impact on the FDI in financial services, and thereby the authors argued that a country with well developed financial markets tend to attract larger amounts of FDI in financial services.

The paper is based on an interesting issue. It is also well written by applying the latest panel econometric techniques. However, I would suggest the authors to incorporate the following suggestions to improve the paper further.
• Results for other control variables need to be elaborated with proper justifications.
• Variables reported in short form (e.g. FINAND, LFS, LNFS etc) needs to be elaborated properly.
• Recent literatures related to the given issue can be incorporated to strengthen the analysis.
• The authors have mentioned about the importance of well functioning and regulated financial market for enhancing FDI inflows and thereby helping to boost the economic growth. However, the empirical relationship, taking economic growth as a dependent variable (is not examined here), can be studied separately to prove the same.


Jithin Podikkalathil - Reply to Reader Comments
January 20, 2020 - 10:37

see attached file


Anonymous - structural queries
December 19, 2019 - 14:12

The authors have addressed a core problem bothering financial economic researchers currently. The authors must be complemented for the choice of such a relevant problem. However I have two comments on the work both from the structural point of view.
1. The authors have used FDI inflow and financial ...[more]

... markets to indicate development. Though this is relevant even FDI outflow could happen because the financial markets are mature and it could boost investment outside of the home country. Therefore should the authors also consider FDI outflow in addition FDI inflow in relating to the measurement of development.
2. The authors have considered financial services as a whole. If the financial services are segmented into banking and non banking financial services and then analysed the results could show more integration towards one of these sets. That would room for a concentrated focus for policy advisory.

The paper is well written and very well structured. These two comments are more from a structural point of view. The authors must be complemented for choosing such a relevant problem.


Jithin Podikkalathil - Reply to Reader Comments
January 20, 2020 - 11:26

see attached file


Anonymous - Reader Comments
December 19, 2019 - 22:12

In this study, the authors examine the short-run and long-run relationship between foreign direct investment (FDI) in financial services and financial development select 26 emerging economies for the period between 2003 and 2015. It is a surprising result that there is a unidirectional causal relationship between financial development and FDI ...[more]

... in financial services. The authors have dealt with one of the most relevant issues in the the realm of international economics with appropriate quantitative method employed.
Nonetheless, I suggest the following structural additions to improve the paper.
1. Literature part could be modified with recent studies to cement the research issues.
2. The results and discussion section could be expanded further with additional explanation.
3. The discussion on co-integration tests could be put more precisely.


Jithin Podikkalathil - Reply to Reader Comments
January 20, 2020 - 11:27

see attached file


Anonymous - Invited Reader Comment
January 06, 2020 - 08:46

Comments on the paper:

Studies have explored if FDI provides impetus to growth, particularly in the context of emerging economies who suffer from dearth of capital resources. There are strong push factors and pull factors governing FDI flows into these economies. Studies have tried to identify factors influencing FDI ...[more]

... inflows and also impact of FDI inflows on host countries growth, employment and so on. Studies have used aggregate FDI inflows and sometimes manufacturing FDI. In a unique attempt, this study seeks to add to the literature by analysing if financial services FDI impacts the financial development of host countries. And also, this study further extends the analysis to examine the two-way linkages between financial services FDI and financial development.

This study used data gathered from sources such as World Bank, IMF and UNCTAD, covered 26 countries for the period of 2003 – 2015. By running Panel cointegration test, it observes that FDI in financial services and financial development of emerging economies are related in the long run. Further, by employing panel vector error correction models, it also observes that there is a long run causality from financial development to FDI in financial services. Results of fully modified OLS regression reveals that a well-developed financial system has potential to attract FDI in financial services.
The paper is well written.

My comment is simple. The study observes unidirectional long-run causality running from financial development to FDI in financial services. Financial development in most of the emerging economies is a product of state intervention. From the pool of their sample countries, can the authors provide some specific country experience in this regard? This will help the other countries which are yet to attract FDI in financial services.


Jithin Podikkalathil - Reply to Reader Comments
January 20, 2020 - 11:28

see attached file


Anonymous - Referee Report 1
January 06, 2020 - 09:50

see attached file


Jithin Podikkalathil - Reply to Referee Report 1
January 20, 2020 - 10:32

see attached file


Anonymous - Referee Report 2
January 23, 2020 - 07:39

I find this issue is an interesting one which has also promising policy implications for the breadth and depth of financial development in emerging economies. The higher degree of financial development will promote the FDI in financial services in emerging economies.

However, I find that this paper has a ...[more]

... minor comment that needs to be addressed as follows:

1. The authors need to employ another econometric technique as long-run result robustness checking.

One the minor revision is done, then I recommend this paper as suitable outlet for publication in your journal.


Jithin Podikkalathil - Reply to Referee Report 2
January 28, 2020 - 07:50

Response to Referee report 2 on “Does foreign direct investment in financial services induce financial development? Lessons from emerging economies”

Thank you very much for your valuable suggestions and comments, which are much appreciated. We will revise the paper as described in the responses below:

1. The authors need ...[more]

... to employ another econometric technique as long-run result robustness checking

Response: We have already done the DOLS estimation for our analysis. We have incorporated that in the revised version of the paper.