The Explorer Islamabad: Journal of Social Sciences

ISSN (E): 2411-0132, ISSN (P): 2411-5487

Vol-1, Issue (9):314-319
www.theexplorerpak.org

FACTORS AFFECTING INVESTMENT BEHAVIOR IN PAKISTAN

Amtul Hafeez1, Saba Safdar2
Assistant Professors at from National University of Modern Languages, Islamabad, 2Graduate from NUML,
Islamabad

Corresponding Author:
Amtul Hafeez
H# 87, st# 35B, I-9/4, Islamabad
amtulhafeezgondal@yahoo.com
Abstract: The objective of the study is to analyze the factors that affect investment behavior in Pakistan over the time
period 1980-2011. Augmented Dickey-Fuller (ADF) is used to check the stationary level of the variables in the model.
The ARDL (Auto regressive distributed lay model) is applied to check the existence of a long-run relationship between
variables. The study employs Error correction model to find the short run adjustments for the investment behavior in
Pakistan. The results show that domestic and foreign savings, gross domestic product are found to have significant
positive effect on investment. However interest rate and inflation rate have strong negative effect on investment
behavior in Pakistan.

Key Words: Investment, Savings, Interest Rate, Economic Growth

INTRODUCTION
National investment is a macro variable which plays
a significant role in economic growth to stabilize
the inflation rate and also to provide employment
opportunities in economy. The employments
situation is promoted through investment in
developing countries. Investment in capital goods
plays a critical role in both the cyclical and long run
performance of any economy. Being the main
components of the aggregate demand, it is leading
sources of economic growth in the long-run. That is
why the capital accumulation has traditionally been
given a prime place in the literature on economic
growth. The neoclassical theory of economic
growth emphasizes that Investment in physical and
human capital into the production process (Solow
1956).
The decade of 1980s, witnessed a decline in
investment in developing countries. This provides
source of inspiration for empirical research into
what determines the private-sector investment.
The investment and specially the private
investment to enhance economic growth, becomes
more important to declare liberalization. That is
why as the engine of economic growth and
development has been accorded the focal place in
developing countries. Given the dominant
significance of private sector investment, it is vital
to investigate into factors affecting investment
decision.
There are different studies considering different
aspects of investment in Pakistan (Khan 1997;

Naqvi 2002). This study attempts to estimate

private investment demand function, using ARDL
model over the period 1980 2011. The objective is
to estimate a well specified private investment
function that must be consistent with economic
theory.
Objectives
1. To identify the correlation between
investment and macroeconomic variables.
2. To identify the factors that negatively
affects investment behavior in Pakistan.
3. To suggest the policies that government
can take to increase the investment level.
Research Questions
What are the factors that affect the behavior of
investment in Pakistan?
DETERMINANTS OF INVESTMENT
Private investment is determined mainly by level of
savings, domestic output, the real interest rate, and
public loans in developing countries (Servn and
Solimano 1992). The neoclassical theory of
investment, based on the work of (Jorgenson 1963),
treats the value of the capital stock desired by a
competitive enterprise as a positive function of its
output level. Accelerator theory also suggests that
as demand or income increases in an economy, so
does the investment made by firms. Furthermore,
when demand levels result in an excess in demand,
firms increase investment to match demand.
Foreign savings have positive impact on investment
but not as much as domestic savings. It is studied

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that income level is directly related with household

savings which are very necessary for investment.
The real interest rate is also considered an
important variable in determining the level of
investment by neoclassical theory. A negative
relationship is expected theoretically because of
increases in the interest payable being disincentive
to investment. However there could positive
relationship between investment and real rate of
interest rate, because higher real rate of interest
would increase savings, volume of domestic credit
will increase as a result, and equilibrium investment
be higher (McKinnon 1973). High rates of interest
rate increases investment through saving according
to (Munir, et al. 2010).
The other important factor that affects the private
sector investment is inflation rate. It is observed by
Commodity price have very strong affect on
investment. If the price of commodity increases
then investment behaves positively because the
investors are interested to invest for earning more
profit.
It is found that public loans generate funds for
investment if these funds are used for productive
propose then public loans are good for growth and
investment (Akram 2011). However, public debt has
significantly negative impact on per capita growth
and investment both in short and long run in case
of Pakistan.
DATA AND METHODOLOGY
The purpose of study is to investigate the behavior
of investment in Pakistan. Since the time series
data shows the discontinuity before the year 1980,
the study is based on data from 1980-2012. Main
data sources are Economic Survey of Pakistan
(various issues) and World Banks annual reports.
Table 1 gives the description of variables.
Table. 1: Variables Description
Variables
Description

Measurement and
Data Source

NI

National
investment

As percent of GDP,
Economic Survey

DS

Domestic savings

As percent of GDP,
World Bank Report

FS

Foreign savings

As percent of GDP,
Economic Survey

GDP

Gross domestic
product

Growth rate , World

Bank Report

RIR

Real interest rate

Annual percentage,
World Bank Report

PL

Public loan

As percent of GDP,
Economic Survey

INF_r

Inflation rate

Annual percentage,
World Bank Report

Investment Model
The functional form of model is as fallows;
NI = f (DS, GDP, FS, RIR, PL, INF_r) (1)
The econometric equation of the investment
model is as follows
NI = 0 + 1 DS + 2GDP + 3FS + 4PL + 5RIR +
6INF_r + 0. (2)
Dependent variables
National investment
In economics investment mean accumulation of
newly produces entities, such as factories, houses,
goods inventories and machinery in country. In
finance, investment means putting money in an
asset to expect that their capital value will
appreciate in future in the form of dividend or
interest earnings.
National income identity is:
GDP = Consumption + Investment + Government
Expenditure
And we have
Investment = GDP - Consumption - Government
Expenditure
Independent variables
Domestic savings
Domestic savings means the process of setting
aside some portion of our income for some future
use. Saving is that portion of our income which is
left after consumption.
S = Y - C
(portion of income that left after
consumption)
Foreign savings
Foreign savings or foreign capital inflow is the
movement of foreign capital into domestic
economy. These saving are calculated as excess of
foreign receipts over foreign payment in terms of
financial investments. It is expected that foreign
savings positively affect the level of investment in
the country.
Gross domestic product
The total market value of the final goods and
services produced in the country in a specific time
period of one year is known as gross domestic
product (GDP). Higher productivity in the economy
is likely to increase the level of investment in the
country. That is there is positive relation between
GDP and investment level.
Real interest rate
Real interest rate is a rate which is adjusted after
removing the inflation effect to show the real cost

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of funds to the borrower and real profit for lender.

It is expected to have negative impact on
investment behavior in Pakistan. The real interest
rate of an investment is calculated as the amount
by which the nominal interest rate is higher than
the inflation rate.
Real Interest Rate = Nominal Interest Rate Inflation (Expected or Actual)
Public Loans
Public sector loans show that how much
government borrows from different sources every
year. Government uses the loans borrowed from
internal and external sources on different
expenditures of the state. Increase in public sector
loans is likely to increase the level of investment in
Pakistan.
Inflation Rate
Inflation rate is a rate which shows the rise in
general price level of goods and services in the
country. Inflation rate is used to measure the
element of uncertainty in economy. Inflation rate is
expected to have negative relation with the
investment level in the country.
ESTIMATION AND RESULTS
Unit Root Tests
This study uses Augmented Dicky-Fuller (ADF) unit
root tests to all variables in order to check the
stationary of data. The results of ADF are given in
Table 2. We find that all variables are either I(0) or
I(1) and none of the variables is of I(2) or higher
order. Therefore we apply ARDL to undertake long
run analysis among variables. The results are given
in Table 3 and Table 4.
Hypothesis:
H0 : Time series are non-stationary.
H1: Time series are stationary.
Table. 2: Results of augmented dickey-filler unit root
test (intercept and trend)
Variabl
t-statistics
Prob
Order
es
of Integ
NI
ADF value -4.323* 0.0123
I(0)
1% level
-3.580
5% level
-3.22
DS
ADF value -5.409* 0.0006
I(1)
1% level
-4.319
5% level
-3.584
FS
ADF value -4.337*
0.009
I(0)
1% level
-4.296
5% level
-3.568
GDP
ADF value -6.886*
0.000
I(1)
1% level
-4.309
5% level
-3.574
PL
ADF value -4.960* 0.0023
I(1)
1% level
-4.323
5% level
-3.580
RIR
ADF value -6.297*

INF_r

1% level
5% level
ADF value
1% level
5% level

-4.309
-3.574
-6.246*
-4.309
-3.574

0.0001

I(1)

Long Run Analysis

Co integration is applied to find out whether there
exists a long run equilibrium relation among the
variables. The study uses the bounds testing
procedure to check the existence of a long run
relationship between the dependent and its
explanatory variables. The order of lags for bound
testing approach is obtained from Unrestricted
Vector Auto regression by means of the minimum
value of Akaike Information Criteria, Schwarz
Bayesian criteria and Hannan-Quinn information,
and the lag length of order (2) is selected. In the
first step, we select a lag order because the
computation of F-statistics for co-integration is very
sensitive to lag length.
There are two critical bounds to test F statistics.
The lower bound assumes that the variables are
integrated at level and there is no co-integration
among the variables while the upper bound
assumes that the variables are integrated at first
difference I(1) and there exist co-integration among
the variables. If F- statistics is higher than the upper
bound than H0 of no co-integration among variables
is rejected. If F- statistics is lower than the lower
critical bound than null hypothesis of no cointegration is accepted which means that cointegration does not exist. If the F-statistic falls
between the critical bounds then the test is
considered inconclusive (Pesaran, et al. 2001)
Auto-regressive Distributed Lag Model
Many tests as Engle and Granger (1987) residual
based test, and Johansen (1988) maximum
likelihood based test are commonly used in
literature for conducting the co-integration.
However, these techniques face many problems
like low power and stationary problems. These tests
do not capture the effect of small data set. To
overcome this problem, the present study applied
the ARDL approach proposed by (Pesaran, et al.
2001). This study extended the ARDL approach to
co-integration. ARDL have superiority on other cointegration techniques. 1). it can be applied when
the variables are of I(0) or I(1) or mutually
integrated, but still it is pre-requisite that none of
the variable is of I(2) or higher order. 2). It cares the
problem of endogenity. 3). This approach also
removes the problems associated with the omitted
variables and autocorrelation. The estimates
obtained from the ARDL approach to co-integration
are unbiased and efficient since they avoid the

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problems that may arise due to serial correlation.

4). comparing to other VAR models, ARDL
technique to co-integration can accommodate
greater number of variables. 5). ARDL approach
performs better and gives more robust results in
case of small data set. A dynamic Error Correction
Model (ECM) can be derived from ARDL through a
simple linear transformation. ECM gives the short
run coefficients without losing the long run
information.
Econometric presentation of models is given as
follows.
NIt = 0 + 1NI t-1 + 2DSt-1 + 3FSt-1 + 4GDPt-1 +
5PLt-1 + 6RIRt-1 + 7INF_rt-1 +
1NIt-1 +
DS
+
FS
+

GDPt-1 +
2
t-1
3
4
5PLt-1 +
6RIRt-1 +
7INF_rt-1 +
Et.(3)
The coefficients s measures the short run
dynamics of the model whereas s represents
the long run relationship. Et is the disturbance
term in this equation.
We develop the hypothesis for long run
relationship of variables;
H0: s = 0 (No long run relationship)
H1: s 0 (Long run relationship
exists)
Once the presence of co-integration between
dependent and independent variables is confirmed
then we move to estimate the long run coefficients
of growth model and the associated ARDL of error
correction model for short run coefficients. In both
the long run and short run model the lag length are
specified on the basis of Schwartz Bayesian Criteria.
NIt = 0 +
1NIt-1 +
2DSt-1 +
GDP
+
FS
+
3
t-1
4
t-1
5PLt-1 +
6IRt-1 +
7INF_rt-1 + Ect-1 . (4)
Table 3 shows the results of Wald test.
Table. 3: Results of Wald Test
Test statistics
Values

Prob.

T statistic

3.0717*

0.0030

F-statistic

6.9741**

0.0035

chi-square

27.8192

0.0002

Note: The calculated statistics indicated by ** and

*are significant at 5% and 1 % level of significance.
Table. 4: Long run Estimates of Investment Behavior
Variables
Coefficients
t-statistics
DS
0.257
2.516*
FS
0.149
1.936**

GDP
PL
RIR
INF_r
R-square
Durbin Watson

0.724
0.029
-0.239
-0.344
0.770
2.193

3.280*
1.633
-1.696***
-2.296*
2
Adjusted R
F-statistic

Note: The statistics indicated by ***, ** and *are

significant at 10%, 5% and 1 % level of significance.
We find that one unit increase in domestic savings
is likely to bring 25% increase in investment level in
the long run and 12% in short run. One unit
increase in foreign savings brings about similar
increase of 15% both in long run and short run. We
analyze that domestic saving are more important
for national investment to increase in the long run.
GDP is one of the major determinants that effect
investment behavior. The results show that 1
percent increase in GDP growth brings a significant
increase of 72% increase in investment level in the
long run. However an increase of 37% is found in
investment in short run.
The estimation result shows that public sector loans
have positive but insignificant affect on investment
behavior in the country both in long as well as short
run. There are two types of effects resulting from
public loans. One is that the increase in public loans
can increase the investment level both in long run
and short run. The second effect is that the increase
in public loans can decrease the investment level as
major part of these loans is spent on the other nondevelopment projects and to finance the budget
deficit. The resulting effect of public loans on
investment behavior is though positive but
insignificant.
One unit increase in Interest rate will bring
decrease of 23% in investment in long run. And 1
unit increase interest rate will decrease our
investment by 9% in short run, because investment
is negatively related with interest rate. People
prefer to save more as to earn more interest so
physical investment is decrease in short run.
Inflation rate is also negatively related with
investment. According to the estimation results 1
unit increase in inflation rate will bring decrease of
34% in investment in long run and 20% decrease in
short run. This is so because when price increases,
the factors of production become expensive and
demand is discouraged. It will lead to decrease the
investment level in the country.
Short Run Analysis
After getting the estimation results of ECM it is
proved that the values of all variables are
significant. The results show that there exist short

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run relationship between dependent and

independent variables.
The variables like DS, FS, GDP, and PL have positive
and significant impact in the short run and play very
important role in determining national investment
behavior in Pakistan. The interest rate and inflation
rate have negative and significant impact in short
run.
Table. 5: Results of Error Correction Model
Variables
Coefficient
t-statistic
DS
0.127
1.892**
FS
0.157
1.681***
GDP
0.371
2.969*
PL
0.037
-1.514
RIR
-0.090
-1.822***
INF_r
-0.204
-1.839***
NI
0.216
1.912**
ECM(-1)
-0.265
-3.216*
R-statistic
0.579543
Adjusted R0.402508
statistic
Durbin Watson
2.213425
F-statistic
3.273613

Note: The calculated statistics indicated by ***, **

and *are significant at 10%, 5% and 1 % level of
significance.
The value of error correction term -0.26 which
shows that 26% backward adjustment towards the
equilibrium is taking place.
CONCLUSION
The purpose of the study is to identify the link
between investment and other macroeconomic
variables like investment behavior and domestic
and foreign savings, GDP, public sector loans,
interest rate and inflation rate. The study contains
the long run as well as short run analysis between
dependent and independent variables over the
time period of 1980-2011.
It is concluded that there exists long run and short
run relationship among the above mentioned
variables. The positive and significant impact of
domestic and foreign savings, GDP, public sector
loans is found on investment behavior in Pakistan.
However impact of interest rate and inflation rate is
found to be negative on investment behavior.
Estimation results of ECM show that short run
relationship is also present in the economic model
that we use in our study. The trends of relation are
found similar both in short run and long run for all
variables.
The study suggests that;
Government can encourage the households
to save more so that more funds can be
provided to finance investment.

Government can encourage the producers

to enhance the production so that further
investment can take place in the country.
Measures can be adopted to reduce the
inflation rate and interest rate as these are
likely to discourage the investment level.
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