Foreign Capital Inflows and Financial Development in Pakistan: A Linear and Nonlinear ARDL Analysis

Abstract

Foreign capital inflows play a significant role in sustainable development of financial sector of any country. This study investigates the impact of foreign capital inflows (including remittances, foreign direct investment (FDI), foreign aid, and external debt) on the financial development of Pakistan. For empirical analysis, this study used linear and nonlinear autoregressive distribution lags (ARDL) techniques with time series data from 1972 to 2022. Findings reveal that FDI, workers’ remittances, and foreign aid support financial development, whereas external debt negatively impacts financial development. Moreover, there appear to be asymmetrical effects of FDI and external debt on the financial development in the long run which reduces to a nonlinear FDI-finance relationship in the short run. The outcomes of this study imply policies that encourage networks for FDI and remittances while discouraging external debt inflows to stabilize the financial sector.