Research Report
THE ROLE OF FOREIGN DIRECT INVESTMENT ON STOCK MARKET
DEVELOPMENT: CASE OF SOUTH AFRICA
PHUTI MOHLOANA
201707419
BACHELOR OF COMMERCE HONOURS
In
ECONOMICS
In
FACULTY OF MANAGEMENT AND LAW
(School of Economics and Management)
at the
UNIVERSITY OF LIMPOPO
SUPERVISOR: MR T Matlasedi
202
DECLARATION
I declare that THE ROLE OF FOREIGN DIRECT INVESTMENT ON STOCK MARKET
DEVELOPMENT: CASE OF SOUTH AFRICA is my own work and that all the sources that
I have used or quoted have been indicated and acknowledged by means of complete
references and that this work has not been submitted before for any other degree at any other
institution.
MOHLOANA PHUTI
Full names
Date
ABSTRACT
This paper investigates the role of foreign direct investment on the stock market development
of South Africa. This paper seeks to determine whether the role of foreign direct investment
on the stock market development of South Africa is complementary or substitute. ADRL
bounds testing is used for short and long run relationship between the variables. The results
of this paper indicate that the role of foreign direct investment on the stock market
development of South Africa is complementary. Other macroeconomic variables that affects
the stock market development are GDP growth and inflation.
ACKNOWLEDGEMENTS
I would like to thank the following for their respective contribution to this study:
 My whole family for the support they have given me throughout, especially my uncle Mr
Tekedi Mohloana for always encouraging me further my studies.
 My supervisor Mr Tony Matlasedi for all his guidance and support, your work is
appreciated.
 Over and above I would like to thank God and my ancestors they have given me
throughout this study.
ACRONYMS
GDP
Gross Domestic Product
FDI
Foreign Direct Investment
ADF
Augmented Dickey Fuller
PP
Phillips Perron
ADRL
Autoregressive Redistributive Lag
ECM
Error Correction Model
ii
DECLARATION…………………………………………………………………………. ii
ACKNOWLEDGEMENTS………………………………………………………………. ii
ABSRACT………………………………………………………………………………... ii
ACRONYMS……………………………………………………………………………... ii
1.
INTRODUCTION AND STATEMENT OF THE PROBLEM…………………. 4
1.1.
PROBLEM STATEMENT………………………………………………………. 5
1.1.1. BACCKGROUND TO THE RESEARCH PROBLEM…………………………. 5
1.1.2. STATEMENT OF THE PROBLEM……………………………………………. 6
2.
PURPOSE OF THE STUDY……………………………………………………. 6
2.1.
AIM OF THE STUDY…………………………………………………………... 6
2.2.
OBJECTIVES OF THE STUDY………………………………………………… 6
2.3.
SIGNIFICANCE OF THE STUDY……………………………………………… 7
3.
LITERATURE REVIEW………………………………………………………… 8
3.1
THEORETICAL LITERATURE………………………………………………… 8
3.1.1 THE THEORETICAL RELATIONSHIP BETWEEN MULTINATIONAL
ENTERPRISES AND FDI IN HOST COUNTRIES………………………………… 8
3.2
EMPIRICAL LITERATURE…………………………………………………….
3.3
SOUTH AFRICAN FINANCIAL SECTOR AND ITS CONTRIBUTION TO
8
ECONOMIC GROWTH……………………………………………………………… 10
3.4
CONCLUSION…………………………………………………………………… 11
4.
METHODOLOGY………………………………………………………………... 12
4.1.
DATA……………………………………………………………………………… 12
4.2.
MODEL SPECIFIFCATION……………………………………………………… 12
4.3.
ESTIMATION TECHNIQUES……………………………………………………. 13
4.3.1. STATIONERITY/ UNIT ROOT TEST…………………………………………… 13
4.3.2. COINTEGRATION……………………………………………………………… 13
5.
RESULTS………………………………………………………………………… 14
5.1.
RESULTS OF UNIT ROOT TESTS……………………………………………
5.2.
ADRL BOUNDS TEST RESULTS……………………………………………… 15
5.3.
ADRL LONG RUN AND SHORT RUN COEFFICIENTS……………………… 16
5.4.
THE RAMSEY RESET TEST…………………………………………………… 17
14
CONCLUSION AND RECOMMENDATIONS………………………………………… 18
REFERENCES …………………………………………………………………………… 19
iii
1. INTRODUCTION AND RESEARCH PROBLEM
The growing stock markets around the world have reinforced the fact that finance is a crucial
source of economic growth. The development of the stock market is of essential significance
when a country wants to enhance investment and economic growth alongside savings. An
efficient stock market boosts investment by identifying and supporting the projects which are
productive and will eventually result in economic development. In most cases the health of the
stock market measures the strength of the economy. Adam and Tweneboah (2008) states that
factors such as foreign direct investment (FDI) and economic liberalization result in the
development of the stock market.
Foreign direct investment is a significant wellspring of capital inflow in most of the developing
countries like South Africa. Adam and Tweneboah (2008) observed a causal relationship
between foreign direct investment and stock market development in Ghana and found that
foreign direct investment stimulates growth, economic growth stimulates stock market
development and implication that FDI stimulates stock market development.
South Africa like many other developing countries needs foreign direct investment inflows to
stimulate growth and the sustainability of the financial sector. There are several factors that the
foreign investors consider before investing in a particular country, such as the economic
outlook of a country, government policy decisions, political and economic uncertainty. For
instance, in 2018 due to political uncertainty and other factors such as corruption clouded the
judgement of the foreign investors and foreign direct investment inflows declined sharply
during that period (UNCTAD, 2018). South Africa is attractive to foreign investors because of
its plentiful natural resources, and certainty of its legal system.
4
1.1. Problem statement
This section discusses the background to the research problem and the statement of the
problem.
1.1.1. Background to the research problem
mc
112
108
104
100
96
92
88
2014
2015
2016
2017
2018
The figure above shows the trend and behavior of the stock market development for the period
2014 to 2018. It is clear from the figure that the stock market development has risen sharply
during period 2014 to 2017 and then declined sharply during the period 2017 to 2018.
fdi
3.6
3.2
2.8
2.4
2.0
1.6
2014
2015
2016
2017
2018
The figure above shows the trend of foreign direct investment for the period 2014 to 2018. The
figure shows a sharp increase from 2014 to 2015, South Africa recorded high foreign direct
investment inflows with infrastructure as the main attraction (UNCTAD, 2014). During the
period 2015 to mid-2016 the figure shows a steady decrease and then declined sharply from
mid-2016 to 2018, South Africa’s foreign direct investment inflows during 2018 declined
sharply due to the country’s political uncertainty and underperforming commodity sector
(UNCTAD, 2018).
5
gdp
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
2014
2015
2016
2017
2018
The figure above shows the trend of economic growth (GDP) during the period 2014 to 2018.
The figure shows a sharp decline during the period 2014 to mid-2016. The figure indicates a
sharp increase from mid-2016 to mid-2017 and then declined during the period from mid-2017
to 2018.
1.1.2. STATEMENT OF THE PROBLEM
From the background, it is clear from the trends that during certain periods foreign direct
investment, economic growth, and the stock market development moves in the same
direction. During the period 2014 to mid-2015 both foreign direct investment and stock
market development shows an upward trend. During the period mid-2016 to mid-2017 both
economic growth and the stock market development shows an upward trend. During the
period from mid-2017 to 2018, foreign direct investment, stock market development and
economic growth declines sharply. The fact that they move in the same direction during
certain periods it might mean that they are correlated to each other and causing each other
to change.
Investigating foreign direct investment and the stock market development, this paper seeks
to investigate the role an increase or a decrease in foreign direct investment has on the stock
market development with the key focus on whether the role is complementary or substitute.
2. PURPOSE OF THE STUDY
2.1. The aim of the study
The aim of the present study is to investigate the role of FDI on the development of stock
market development in South Africa
2.2. Objectives of the study
To achieve the aim of this study the stock market development will be proxied by Market
Capitalization. Furthermore, to avoid the problem of omitted bias, two more variables in
6
the form of FDI and inflation will be added in the model. Therefore, these are the objectives
of the study:
I.
To investigate the relationship between FDI and the stock market development.
II.
To determine if the role of FDI on the South African stock market development is
complementary or substitute.
III.
To determine the relationship between inflation, economic growth, and the stock
market development.
2.3. Significance of the study
There is a limited number of studies conducted on the role of FDI on the stock market
development. It appears that the existing research on the issue under investigation emphasizes
the role of FDI and the impact it has on the stock market development of numerous countries.
However, in South Africa studies focusing on the role of FDI on stock market development is
still untapped.
7
3. LITERATURE REVIEW
3.1. Theoretical Literature
3.1.1. The theoretical relationship between multinational enterprises and FDI in host
countries:
The Product life cycle theory can explain investment by multinational enterprises in some
cases. This multinational companies generally brings technology in the host countries (Nayak
and Choudhry, 2014). Once market for such commodities is established and the products are
acquainted in the foreign markets, the firms instead of exporting would rather establish
subdivisions in a foreign country in the form of FDI (Nayak and Choudhry, 2014). For the
multinationals to protect their position in the foreign markets developed via exports, they set
up subdivisions in the host countries (Nayak and Choudhry, 2014). Multinational enterprises
may invest in foreign countries due to home country’s policies of the government in terms of
the incentives obtainable in the host country by the government (Nayak and Choudhry, 2014).
Lastly the when the home exchange rate is stronger than the foreign exchange rate it becomes
beneficial for the multinational enterprises to invest in a foreign country (Nayak and Choudhry,
2014).
3.2. Empirical Literature:
This section comprises examination of the previous findings on the macroeconomic
determinants of stock market development from the developing countries. Azeez and Obalade
(2019) examined macroeconomic determinants of stock market development in Nigeria and
reported that the main macroeconomic determinants of stock market development in Nigeria
are banking sector development, stock market liquidity, foreign direct investment and income
level (GDP) while inflation rate which measures macroeconomic stability and savings rate do
not significantly explain stock market development. Jun, Hongzhong, Thierry, and Yannick
(2015) found that stock market liquidity and financial openness represented by foreign direct
investment and private capital flows are important determinants of stock exchange
development in Cameroon. Yartey (2008) studied the institutional and macroeconomic
determinants of stock market development by means of a panel data of 42 developing countries
from 1990 to 2004 and reported that macroeconomic determinants such as income level, gross
domestic investment, banking sector development, private capital flows, and stock market
liquidity are central determinants of stock market development in developing market
8
economies. Ho (2017) examined the determinants of stock market development in South
Africa, by means of ADRL bounds testing, the results in the long run banking sector
development and economic growth have positive long-run impact, whereas inflation rate and
trade openness have negative long-run impact on stock market development. In the short run,
the results find that economic growth have positive impact, while inflation rate, real interest
rate, and current period of trade openness have negative impact on stock market development
Khalim and Shabbaz (2009) studied the impact of FDI on the stock market development of
Pakistan, with key interest revolving around the complementary or substituting role of FDI in
the stock market development of Pakistan and also examined the other major contributing
factors towards the development of stock market. Using ADRL bounds testing, their results
support the complementary role of FDI in the stock market development of Pakistan and other
macroeconomic variables affecting stock market development are domestic savings, GNP per
capita, and inflation. Claessens, Klingebiel and Schumakler (2001) studied the determinants of
the growing stock market activity by using a sample of 77 countries indicated that FDI is
positively correlated with stock market development and value traded, meaning that it
complements domestic stock market development and not a substitute. Adam and Tweneboah
(2008) using multivariate cointegration and error correction model, examined the impact of
Foreign Direct Investment (FDI) on the stock market development in Ghana and the results
indicate that there exists a long run relationship between FDI, nominal exchange rate and stock
market development in Ghana. Raza, Iqbal, Ahmed, Ahmed, and Ahmed (2012) studied the
role of stock market development in the case of Pakistan using Ordinary Least Square (OLS)
method of regression. Using annual time series data to estimate empirical relationships among
variables, the results disclose a positive impact of foreign direct investment along with other
explanatory variables in developing Stock markets of Pakistan.
9
3.3. South African financial sector and its contribution to the economic growth:
June 2000
June 2010
Relative size 2010
% of GDP
size
R68.6bn
R203.8bn
10.5%
Assets of which:
R1890bn
R6040bn
252%
Banks
R730bn
R3040bn
127%
Long term insures
R630bn
R1440bn
60%
Short term insures
R50bn
R90bn
4%
R1480bn
62%
Pension funds (public and R470bn
private)
% of employment
Employment
286000
356353
3.9%
% of corporate taxes
Tax contribution
n/a
R21bn
15.3%
Source: National Treasury policy document, a safer financial sector to serve South Africa better
The South Africa’s financial sector contributes 10.5 percent of GDP of the economy on annual
basis. The financial sector employs 3.9 per cent of the working population and contributes 15.3
percent in the corporate taxes (National Treasury, 2011). As compared to the comprehensive
economic growth of 3.6 percent, the financial sector of South Africa grew by the rate of 9.1
per cent since 2000 (National Treasury, 2011). The financial sector became one of the leading
employers in South Africa between 2000 and 2010 and the level of employment in the subsector grew by 24.5 percent (National Treasury, 2011). Between 2000 and 2010 the total assets
of the financial sector grew strikingly by recording nominal compound average of 12.3 per cent
(National Treasury, 2011). The South Africa’s financial sector assets currently stands at 298
per cent of GDP which exceed majority of the developing market economies (National
Treasury, 2011). Resulting from the need for favourable economic growth it is essential to
make certain that the financial system of South Africa stays economical (National Treasury,
2011).
10
3.4. Conclusion:
Most of the studies, Azeez and Obalade (2019); Jun, Hongzhong, Thierry, and Yannick (2015);
Khalim and Shabbaz (2009); Claessens, Klingebiel and Schumakler (2001); Adam and
Tweneboah (2008); and Raza, Iqbal, Ahmed, Ahmed, and Ahmed (2012) reported FDI as
macroeconomic determinant of stock market development and also reported a positive link
between FDI and stock market development in the developing countries of interest. Azeez and
Obalade (2019); and Ho (2017) reported inflation as macroeconomic determinant of stock
market development and indicated a negative relationship between inflation and the stock
market development in the developing countries. Azeez and Obalade (2019); and Ho (2017)
reported that economic as macroeconomic determinant of the stock market development is
linked positively with stock market development. Yartey (2008) studied macroeconomic
determinants of the stock market development but did not incorporate FDI, economic growth
and inflation like many other studies mentioned in this paper. Khalim and Shabbaz (2009);
Claessens, Klingebiel and Schumakler (2001); Adam and Tweneboah (2008); and Raza, Iqbal,
Ahmed, Ahmed, and Ahmed (2012) reported that the role of FDI on the stock market
development is complementary rather than substitute.
11
4. METHODOLOGY
The previous segments reviewed literature on different theories and empirical studies on the
role of FDI on the stock market development of numerous countries. This section discusses the
research methodology used to achieve the aim of the study.
4.1. Data
This study uses annual time series data which covers the 1990 and 2018 period. The data has
been obtained from the World Bank and Quantec Easy Data
Concept
Source
Variable
Market capitalisation
Quantec easy data
MC
Inflation
World development indicators
INF
Foreign direct investment
Quantec easy data
FDI
Economic Growth
World development indicators
GDP
4.2. Model specification
To respond to the question of whether FDI is complementary or substituting stock market
development, the model by Kalim and Shahbaz (2009) and Adam and Tweneboah (2008)
among others was adopted. The estimated linear regression is as follows:
𝑀𝐶𝑡 = 𝐵1 + 𝐵1𝐹𝐷𝐼𝑡 + 𝐵2𝐼𝑁𝐹𝑡 + 𝐵3𝐺𝐷𝑃𝐶
Where MC represents market capitalization as the ratio of stock market development, FDI
represents foreign direct investment, GDP represents GDP growth, and INF represents
inflation.
12
4.3. Estimation techniques
4.3.1. Stationarity/Unit root test
The first step when dealing with time series data is to test for stationarity and most of time
series data are nearly all non-stationery. The study adopts the Phillips Perron (PP) and
Augmented Dickey Fuller (ADF) tests. The unit root is employed to ensure that the variables
are integrated of the same order. Ncanywa and Masoga (2018); Fadli, Nurul, Nurmadihah,
Zuraida, Norazidah and Kamaruman (2011) argue that it is an imperative phenomenon for a
series to be tested for stationarity since it can affect it behaviour. Ncanywa and Masoga (2018);
Dolado, Gonzalo and Marmol (1999) highlighted that unit roots must be removed through
differencing as regression is required to be applied. Alam and Ahmed (2010) highlight that
series are all tested for stationarity either at level, first difference or second difference utilising
Phillips Perron (PP) and Augmented Dickey Fuller tests.
4.3.2. Cointegration
Ncanywa and Masoga (2018); Pesaran, Shin and Smith (2001) recommended that ADRL
bounds test be used to test if cointegration exists in the series. Hence the autoregressive
redistributive lag (ADRL) was employed to establish the relationship among the variables. The
ADRL approach considers short-run and long-run relationships concurrently. Ncanywa and
Masoga (2018); Pesaran and Shin (1997) argue that ADRL bounds test is useful where the unit
root test shows different orders of integration in addition faced with small sample size. For
cointegration to exist the computed F-statistic must be above the lower bound critical value
and the upper bound critical value, hence the bounds test gives two critical values.
The ADRL approach also runs the error correction mechanism (ECM). Ncanywa and Masoga
(2018), the error correction coefficient is important in the error correction estimation since the
higher coefficient shows higher speed of adjustment of the model from the short-run to longrun.
13
5. RESULTS AND DISCUSSIONS
5.1. Results of unit root tests
lmc
Differenced lmc
2.08
.2
2.04
2.00
.1
1.96
.0
1.92
1.88
-.1
1.84
-.2
1.80
1.76
-.3
1.72
1.68
1985
1990
1995
2000
2005
2010
-.4
1985
2015
1990
1995
2000
2005
2010
2015
The figures above show a graphical representation for log of market capitalization in both level
and differenced forms. The variable seems not to be trending in level form, however, the second
figure with the differenced variable satisfies the condition of stationarity with the mean
hovering around the mean of zero horizontally along the x-axis.
fdi
Differenced fdi
6
1.2
5
0.8
0.4
4
0.0
3
-0.4
2
-0.8
-1.2
1
0
1985
-1.6
1990
1995
2000
2005
2010
2015
-2.0
1985
1990
1995
2000
2005
2010
2015
The figures above show a graphical representation for foreign direct investment (FDI) in both
level and differenced forms. The variable seems not to be trending in level form, however, the
second figure with the differenced variable satisfies the condition of stationarity with the mean
hovering around the mean of zero horizontally along the x-axis.
14
gdp
6
5
4
3
2
1
0
-1
-2
-3
1985
1990
1995
2000
2005
2010
2015
The figure above represents gross domestic product (GDP) and from the visual inspection it is
expected that the data will be stationery at level as the mean appear strongly to hover around
the mean of zero horizontally along the x-axis.
Differenced inf
inf
20
4
16
2
12
0
8
-2
4
-4
0
-6
-4
1985
1990
1995
2000
2005
2010
2015
-8
1985
1990
1995
2000
2005
2010
2015
The figures above show a graphical representation for inflation in both level and differenced
forms. The variable seems not to be trending in level form, however, the second figure with
the differenced variable satisfies the condition of stationarity with the mean hovering around
the mean of zero horizontally along the x-axis.
5.2. ARDL Bounds test results
Table ADRL bounds test results, 1985-2018
F-Bounds Test
Test Statistic
Null Hypothesis: No levels relationship
Value
Signif.
I (0)
I (1)
Asymptotic:
n=1000
F-statistic
7.284442 10%
2.37
15
3.2
K
3
5%
2.79
3.67
2.5%
3.15
4.08
1%
3.65
4.66
The table above shows cointegration results of the bounds test. The model has four variables,
therefore there are three independent variables in the model, hence k=3. The calculated Fstatistic is 7.284442 which is greater than the lower bounds critical value of 3.65 and the upper
bounds critical value of 4.66 at 1% level of significance. This implies that the null hypothesis
of no integration cannot be accepted. Therefore, there is a cointegrating relationship between
the variables.
5.3. ARDL Short run and long run coefficients
Short-run coefficients
Variable
Coefficient
Std. Error
t-statistic
Pro.
LMC (-1)
0.034291
0.176348
0.194450
0.8472
FDI
0.030629
0.015065
2.033067
0.0516
INF
-0.013174
0.003517
-3.745239
0.0008
GDP
-0.005767
0.006399
-0.901291
0.3751
C
1.881209
0.324474
5.797715
0.0000
ECM
-0.965709
0.149681
-6.451774
0.0000
Long-run Coefficients
Variable
Coefficient
Std. Error
t-statistic
Prob.
FDI
0.031716
0.012692
2.498926
0.0186
INF
-0.013641
0.003668
-3.719357
0.0009
GDP
-0.005972
0.006703
-0.890900
0.3806
C
1.948008
0.057408
33.93298
0.0000
The table above shows long run and short run coefficients of the stock market development
model. In the long run, it is projected that one percent increase in foreign direct investment is
associated with 3.2 percent increase in market capitalization. This is an indication that the
16
nexus between foreign direct investment and market capitalization is complementary not
substitute. The long-run positive association between foreign direct investment and stock
market development is consistent with earlier studies by Kalim and Shahbaz (2009); and Adam
and Tweneboah (2008).
In the short run foreign direct investment is linked positively with stock market development.
This again indicates that in short run the relationship between foreign direct investment and
stock market development is complementary. This positive association is consistent with the
earlier study by Kalim and Shahbaz (2009). Even though the coefficients are significant for
inflation in both short and long run, the impact is extremely low. The influence of GDP is
insignificant in both short and long run.
The coefficient of the error correction term denoted by ECM is -0.965709 indicating that the
system will eventually revert to equilibrium. Therefore, the disequilibrium will be corrected
through short run alterations at a speed of 96.6 percent and that is considered a very high speed
of adjustment.
5.4. The Ramsey RESET test
TEST
H0
Ramsey The
RESET
model
Test
P-
Statistic
Value
is 1.149760 0.2603
correctly specified
Conclusion
Do not reject H0 because P-Value is
greater than the level of significance at
5%
The table above shows the result from the Ramsey RESET test. The null hypothesis states that
the model is correctly specified. Since the p-value is greater than 5% level of significance, the
null hypothesis is not rejected. Thus, the model is correctly specified.
17
CONCLUSIONS AND RECOMMENDATIONS
This paper investigated the role of foreign direct investment on the stock market development
in South Africa. The primary aim of this paper was to investigate the role of foreign direct
investment of the stock market development in South Africa. The secondary aims/objectives
included to investigate the relationship between foreign direct investment and stock market
development, to determine if the role of foreign direct investment on stock market development
is complementary or a substitute, and to determine the relationship between inflation, economic
growth and stock market development.
The study is quantitative in nature and has employed yearly data covering the period 1985 to
2018. The ADRL bounds testing techniques were employed for testing the short and long run
relationship between the variables in the market capitalization model. The results from the
ADRL bounds indicated that there exists a long run cointegrating relationship between
variables in the market capitalization model. In estimating the ADRL short and long run
equations, it was shown that there is a positive relationship between foreign direct investment
and stock market development, thus confirming that the role of foreign direct investment on
stock market development is complementary. It was found that the relationship between
inflation and stock market development is negative. It was also found that the relationship
between inflation and stock market development is negative. The error correction model
revealed that 96.6% percent of the disequilibrium in the market capitalization model will be
corrected each year.
The results from this study have certain implications for policy discussions. Because the results
show that foreign direct investment complements the stock market development in the long
run, a policy directed at encouraging foreign direct investment inflows into South Africa can
be recommended. The South African government can encourage foreign direct investment by
assuring political stability and eradication of corruption. However, this recommendation should
not be too excessive to negatively impact the domestic firms critical to the development and
growth of the South African economy.
18
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