Role of Foreign Direct Investment in Malaysian Economy Finance Essay

According to research by Mello, JR (1999) was defined FDI as a form of international, inter-firm co-operation that involves significantly equity stake and effective management decision power in or ownership of foreign enterprises. FDI also considered as desirable because it can enhance the productive to the country, in order to bringing into new technology and training skilled workers ( UNCTAD 2003:4 ) FDI is different from other major forms of foreign investment in that it is motivated largely by the long term profit prospects in production activities that investors directly control. ( Wong, 2005). FDI is the main sources of flows resources from developing countries of net flows for large share. ( Chiara, 2009) THE FDI FLOWS IN MALAYSIAN ECONOMY. Foreign direct investment is the major contributor to the Malaysian economy. The FDI flows can fluctuate from year to year . Malaysia recorded RM134 billion during the period 1990 -1999. In years 2000 until 2009, the net FDI inflows was increased RM152 . The FDI flows in Malaysia has change due to two factors. Firstly, the FDI inflows increasingly been channeled into the higher value- added in services sector which is the financial services and shared services operations. The value- added and contribution to the growth into these sector are lower amount of FDI is higher more skill intensive and have higher labour productive. Secondly is the raising competition of FDI in the region from new emerging markets economies such as PR China, India and Vietnam as well as established investments centers , namely Singapore and Hong Kong SAR. In years 2000 until 2009, the portfolio outflow is steadily growing over the years which is averaging about 3.9% of GDP. It shows that the liberalisation of the foreign exchange administration rules since 2005 has allowed for greater flexibility for residents to invest abroad. ( Annual Report, 2009). FDI outflow in Malaysia can occur in many reasons such as the excess savings over investment and the Malaysian companies are aggresively seeking higher returns from abroad.

1.1 Problem statement

The foreign investor will invest in Malaysia depends on the business environment. Not all the foreign investor willing to take the high risk if the condition of the business environment is not suitable to make investment. The main problem of this study is determine the factor that contribute to the volatility of the FDI flows. From that, the factor will effect of the volatility of the Flow.

1.2 Research objective

The objectives of this study are as follows:- 1.) To determine the factors that effect the volatility of FDI flows in Malaysia 2.) To determine whether there is a relationship between FDI and the variables such as exchange rate, Market size and inflation 3.) To examine the effect of the volatility of FDI flows in Malaysia

1.3 Scope and limitations of the study

1.3.0 Scope

The scope of this study will cover the Malaysia only. The study will use the monthly data of CPI from the year 1980 up to December 2010. Apart from that, this study will also use monthly exchange rate that covers from the year 1970 until January 2011 respectively while data of GDP will be taken from the year 1980 to 2010.

1.3.1 Limitations of the study

While preparing this study, there are several constraints and limitations that have been figure out since the study been conducted from the beginning such as lack of time, difficulty of finding information, and lack of data accuracy. Lack of time Since this study at the beginning semester, they need a lot of concentration which need a lot of time in preparing the research report and the due date of the submission of the report. Beside that, it require a lot of time in gathering information, collecting the data, study on finding and literature review but it also need time in writing the report. The cost involved Cost also became constraint in completing the studies such as photocopying, cost of using internet and printing the journal and data. As a student, it considers a lot of money needed when preparing this research. Lack of knowledge In order to complete this study, the guidance from the advisor and experts are really needed because the lack of knowledge and experience in conducting the research. Lack of accurate information While doing this research, the accuracy of the information and data that will be used is important to get a good result. We also not familiar with the software such as Data stream in order to get the data and give us the difficulty to find the suitable data. To get the better study, accuracy of data is important to support the research and to give the additional information while doing the research.

1.4 Significance of the problem

Most of the previous studies have been done by the researcher to see the relationship between FDI with other macroeconomic variables. Since this study focus only on the three variables, it would make a difference and would give some benefits to the investors, company, students and university.

1.4.1 Significant to the investors

As to investors, this study will make them to be more alert or sensitive towards any changes in the exchange rate. This study will help the investors to make an investment and reduce the potential of loss on their investment.

1.4.2 Significant of the students

This study will provide information to the student about the relationship between FDI and exchange rate, GDP and CPI. The study also might help the student to use it as their reference and additional materials for their study purposes in the near future

1.4.3 Significant to the University

The study will be used by the university as a material for academic purposes as well as a reference for other students to review and do research in the future

CHAPTER 2 LITERATURE REVIEW

2.0 Introduction

Foreign direct investment plays a major role in the development and growth to the Malaysian economy. In order to attract more inflow FDI in our country, the government introduced policy reform include the establishment of free trade zone on early 1970, the introduction of Investment Incentives Act 1988 and more liberal incentives introduce. The inflow FDI in our country increase since the government introduce these policy.

2.1 LITERATURE REVIEW

The volatility of FDI flows in Malaysia has been studied by many individuals especially scholars in economics area that come out with many different ideas. There are some studies argue that the exchange rate can affect the FDI flows. In the previous studies by Gorg and Wakelin,(2002) on the effect of exchange rate on outward U.S. FDI flows into developed countries and inward FDI flows into the United states from those same developed countries shows that there is no evidence that the exchange rate effect the outflow and inflows U.S FDI flows. According a study by Bleaney and Greenaway (2001) show that there is strong negative effect between volatility of real exchange rate and FDI flow but their study focus on total investment not FDI . In a study done by Alaba (2003), to determined the magnitude and the direction of the effects of the exchange rate volatility and the FDI flows in agricultures and manufacturing sectors in Nigeria. The GRACH model was used to measure the volatility of exchange rate, and the error correction methodology also used for empirical investigation in order to test the effect of both the official and parallel market exchange rates on FDI flows to agriculture and manufacturing sectors. The result shows that the official market exchange rate movement significantly reduces FDI inflows to agriculture sector and the manufacturing sector is not significant. For the volatility coefficient show that both of the sectors is not significant in FDI inflows. The previous finding by Cushman (1985, 1988) and Goldberg and kolstad (1995) found that the positive impact on exchange rate volatility in FDI flows. However Urata and kawai (2000) and Benassy, (2001) shows the negative impact on their studies. On their studies, they found that the high exchange rate volatility discouraged FDI, and the local currency promoted FDI from developed countries. There are some reasons of the different impact of the exchange rate volatility to the FDI such as aggregation problem and the lack of adequate treatment of exchange rate volatility. Froot and Stein (1991) and (Sazanami, Yoshimura and Kiyota (2001) were examined the impact of the exchange rate volatility in Japan FDI for the different period. In these studies, they found the depreciation of different effect in another industries. Meanwhile, a study by (Ajayi, 2004), (Khan and Bamou ,2005), (Mwega and Ngugi (2005), show that there is possible effect on exchange rate volatility on FDI. The previous study found that how Exchange rate volatility and FDI flows can be affected in two ways. According to a study by Kohlhagen,(1997) and Dixit, (1989) the behavior of foreign investors to postpone their investment decisions can effect the exchange rate volatility and FDI flows. (Campa , 2003) found that the risk neutral shows the behavior of investors causes the exchange rate volatility of US inward FDI inflows decline in 1980. The other studies by Dixit and Pindyck, (1994) show the adjustment of the cost investment means that the difficulty of the investors get back their decisions once it is made. When the investors postpone their investment decisions, the investor will lose their any expected profit but they still have the ability to get more profit in future. The investors who delay their investment decisions will faced with uncertainty is greater for industries in which the product is life cycle or the expected firm specific assets is long.( Blonigen 1997, Dunning 1993). According to research by Shatz and Venables,2000), they were suggest a theory related to the types of FDI, which is vertical and horizontal (market seeking). Vertical FDI occur when international market searching for the lower cost of production meanwhile horizontal is establishing the same production activities into different country. Gross domestic product and Gross nominal product measured for market size. There are some literature found that the relationship between FDI and GDP is positive.(Campa,1993: Culem,1993: Chakrabarti,2006). Meanwhile some literature show the negative relationship of GDP and inward FDI to Mexico during the period 1980 to 1995 using the Generalized Least Square (GLS method). (Thomas and Grosse, 2001) Based on the studies on Borenztein et al.1998) show that the negative and significant was found for market size. The market size of home country will determine the firm to more capable of expand their production. One factor that can give impact for investor profit is the rate of inflation. Normally, it assumed that the higher price is the more profit the investors will get but the high inflation can be viewed as a barrier to FDI. The studies on determinants of FDI in countries in southest Europe from 1996 to 2002 by Botric and skuflic (2006) found that FDI had a positive but insignificant effect to inflation. It is also being found on FDI flows in Latin America, shows that the FDI flows had a negative but insignificant effect on inflation. (Trevino et.al, 2002)

2.2 CONCEPTUAL FRAMEWORK

In this study, there are three macroeconomic variables that are selected to test the relationship between FDI and the variables. INDEPENDENT VARIABLES DEPENDENT VARIABLES EXCHANGE RATE FDI MARKET SIZE INFLATION Figure 1 Dependent variables:- -Foreign direct investment in Malaysia is measured by annual inflows of FDI. Independent variables:- Market size- Gross Domestic Product is measured for the size of home country market Exchange rate is measured by Real effective exchange rate (Kiyota and urata,2004) Inflation is measured by CPI.

2.3 Conclusion

This chapter normally tell the supporting theory that I use in my studies by referring the previous studies that have been done in order to support my studies. We can see clearly, the argument, theory, opinion, and method that the researcher used on their study . This chapter also explained the conceptual frame work that I will be using on my studies.

CHAPTER 3-RESEARCH DESIGN

3.0 INTRODUCTION

This study is explaining about the methodology being used as well as data collection for the independent variables and dependent variable. To test the relationship between the variables, the Simple Ordinary Least Squares ( OLS) equation regressions are applied by using annual data of FDI, monthly data for CPI and exchange rate and the data of GDP will cover from year 1980 to 2010. To estimates the volatility of the variables, the E-GARCH MODEL was used. In this method,

3.1 Data, population, Sampling method

3.1.1 Data collection

The data of this study will be collected through secondary data which refer to the information assemble from the sources that already exist through the other researcher conducting the current studies ( Sekaran, 2003). The data also can gathered from published articles provided through the web browser. The data of the variables will be taken form BNM statistical bulletin and world bank.The data will be collected by annually and monthly.

3.1.2 Population

The population of this study is the foreign investors who invest in Malaysia.

3.1.3 Sampling method

3.2 Analysis of the data

For the analysis of the data, we will use the specific software .This study will use the E-views software to get the result. Using EGARCH method, we will use the historical data in order to know the volatility of FDI. To know the volatility of the data, it will be measured by conditional variance which is an explicit multiplicative function of lagged innovations.

3.4 Hypothesis Development

3.4.1 Hypothesis 01 The hypothesis 1 shows the relationship between inflation and FDI. It is to shows how far that coefficient of the two variables. H0= There is no relationship between inflation and FDI H1=There is a relationship between inflation and FDI 3.4.2 Hypothesis 02 H0= There is no relationship between exchange rate and FDI H1= There is a relationship between exchange rate and FDI 3.4.3 Hypothesis 03 H0=There is no relationship between market size and FDI H1=There is a relationship between market size and FDI 3.4.4 Hypothesis 04 H0= There is no relationship between inflation, exchange rate, market size and FDI H1=There is a relationship between inflation, exchange rate, market size and FDI

Summary of chapter

This chapter will explain more about the data collected , population, method that I used on my studies , and the hypothesis from the variables.

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