The Impact of Financial Market Development on FDI in Developed and Emerging Countries

Global financial market has developed tremendously in the last two
decades and has affected financial flows and the flow of international
investments. With subdued global economic activities and
generalized slowdown in emerging markets, countries need to
manage vulnerabilities in the financial markets and rebuild resilience
against potential shocks while lifting growth through the attraction of
foreign investments. Sustainable macroeconomic policies must be in
place coupled with financial stability to sustain global businesses.
This paper examines the relations between financial market
development and foreign direct investment (FDI) for the United
States and Malaysia from 1981 to 2013. We divide financial market
development into stock market and banking sector development. Our
results show that higher stock market liquidity draws more FDI into
the developed U.S., signifying higher foreign investors’ confidence
and the importance of equity capital financing opportunities to foreign
investors. In Malaysia, banking sector development has a
significantly negative effect on FDI inflows, suggesting two
possibilities: FDI is considered a substitute for financial development,
or excess liquidity in the banking sector is perceived by foreign
investors as having higher risk of financial fragility, hence results in
lower FDI inflows.

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