Determinants of Foreign Direct Investment: Evidence from Ethiopia

Abstract

This study examined how the Foreign Direct Investment inflows in Ethiopia is determined by, the financial sector development, domestic investment, lending interest rate, exchange rate, human capital development ,trade openness and domestic market potential in Ethiopia. In doing so, the study used a VECM with co-integration based on secondary data from 1975-2014 collected from various sources. The study revealed that, FDI in Ethiopia is highly determined by domestic investment, lending interest rate, exchange rate depreciation, domestic market potential and trade openness. However, human capital development and financial sector development are found to be an insignificant effect on FDI in Ethiopia. So that, the government of Ethiopia needs to work towards increasing the countries market potential by further enhancing the economic growth. Besides, it needs to continue the existing managed floating exchange rate regime, modifying the existing lending interest rate based on the kind of investment and kind of benefit the government and the country will have got, work towards encouraging the import substituting foreign direct investment.

Keywords: Vector Error Correction Model, FDI, Depreciation, Co-integration