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Foreign Direct Investment, Financial Development and Economic Growth Evidence from Saudi Arabia

This study is an effort to explain and establish a relationship among foreign direct investment, financial development and economic growth in Saudi Arabian context for the period of 1970 to 2015 by employing Vector Auto Regression (VAR) and modified Granger Casualty Models. The result of Johansen co-integration test illustrates that no long run co-integration can be established among the variables. VAR has established a link between economic growth, financial development and foreign direct investment. The Granger causality test also confirms that economic growth causes foreign direct investment and financial development which is a unidirectional causality running from economic growth towards foreign direct investment and financial development. No significant causality can be observed empirically between foreign direct investment and financial development. This feature can be attributed to the fact that Saudi Arabian economy is still heavily dependent on its oil resources which is the driving force behind growth. Impulse Response Function has been utilized in order to observe the response to the shocks among the variables.


Introduction and Theoretical Background
In order to substantiate the growth of economy, countries have kicked off multiple set of reformation in the economies. Studies manifest that economies incorporating growth led programs stimulates the economic liberalization which leads to the inflows of foreign direct investment. The FDI usher in multi facets developments which sequentially spur the growth of the countries (Balasubramanyam et al., 1996;Agarwal, 2001). In comparison to other modes of capital flows, the attributes of FDI inflows are unwavering and assists the economy in multiples ways. FDI inflows, in its multifarious dimensions influence the economic welfare, growth and development of the recipient economy (WIR93 &99). FDI reveals itself in the shape of TNCs, which link with the local economy and set up backward and forward linkage in the economy. Further it creates spillover advantages for the local firms in terms of enhancing the efficiency. Likewise; there is promising opportunities in term of employment opportunities.
In this line, this paper aims to unfold the linkage among the foreign direct investment, financial development and economic growth in the Saudi Arabian economy. Since the joining of the World Trade Organization in 2005, the country has advanced the investment milieu in order to unfold the trade and investment. US, Japan, France and the leading gulf economies have led the investment influx in the Saudi economy. Real estate, petrochemicals and contracting sector are the leading arenas that have garnered the foreign direct investment in the country. The country promises to be an ideal destination for foreign direct investment on account of having minimum energy prices. Further the shift of business related capital and gains to other countries are allowed. Thus with the current reforms in the area of foreign direct investment, it shall boost the economic growth of the Saudi economy. In line with foreign direct investment, financial development is also central to stimulate the economic growth of the economies (Levine, 2005;Demirguc -kunt and Levine, 2008). Studies related to Saudi economy manifest the significance of the financial development on the economic growth of the economy (Ibrahim, 2013;Samargandi, Fidrmuc and Ghosh, 2013). In the Saudi economy, banks are professionally managed and regulated by SAMA, which per se has strongly taken care of the risk related to financial domain. Further the capital market in Saudi Arabia has gone through multiple reforms so as to attract capital inflows from foreign investors. The Saudi vision 2030 aims to enhance the foreign direct investment from the present position of 3.8 percent to 5.7 percent in 2030 and assist in escalating the GDP size (rank wise) from 19 th to 15 th in the global economy by the stipulated time frame.

Review of Literature
Multiple studies have revealed that the escalated usage of FDI has been an important source to augment the economic growth of the economies. As a matter of fact, studies revealing the potent of FDI in enhancing the economic growth, further impart caution that the positive influence of FDI hinges on multiples pedestals including the development of the financial landscape of the economy (Blomstrom et al., 1992;Borensztein et al., 1998 andAlfaro et al., 2004).Thus it is pertinent to appreciate the facet of financial development. The importance of financial system on the economic growth is traced to the magisterial work of Bagehot, W. (1873) and Schumpeter, J. (1911). Of late, it has been reinforced by the study highlighting the fundamental contribution of the financial matrix in the growth of the economy (Levine 1997).Studies highlighting the importance of financial development in enhancing the economic growth of the economy are marked as supply leading hypothesis. These studies reveal that development of financial system shall escalate the economic growth. Thereby the pertinent related studies in form of McKinnon (1973), Shaw (1973), King and Levine (1993), Levine (1997), Rajan andZingales (1998), Darrat, (1999), Hussain and Chakraborty (2012) unearth that advancement of the financial system is central input for the growth of the economy. The importance of banking sector and stock market is pertinent for the financial development and economic growth of the economies (Standley, 2010;Shahbaz et al., 2008).
The performance of the FDI has been more confirming and positive on the landscape of the developing economies than to the developed world. FDI encompasses not only the channelization of capital, but covers multiple modes in the manifestation of technology and expertise skills. Likewise, the economic growth is goaded by multiple local and global ingredients covering the external investment. Over the preceding few decenniums, there have been substantial investigation on the linkage between the foreign direct investment and economic growth. Selected researches report that the potent of foreign direct investment have positively driven the growth of the developing economies (Bloomstorm et al. 1992;Borensztein et al 1998). Gupta & Singh (2016) investigates the linkage between foreign direct investment (FDI) and economic growth (GDP) for Brazil, Russia, India, China and South Africa (BRICS nations) individually for the time period 1992-2013.The study revealed the existence of one way GDP led FDI causality for Brazil, India and China, whereas there is no linkage between the purported variables for Russia and South Africa. Basu, Chakraborty & Reagle (2003) through the fabric of panel cointegration, investigates the linkage between FDI and growth for a set of twenty three developing economies. The study manifest two way relationship between the stipulated variables in the unfasten economies, whereas causality run unidirectional from GDP to FDI in the tightened economies. Trevino, et al., (2003) through the pooled data from 1990-99 gauged the role of foreign aids and FDI in the five developing economies. The study reported that the positive influence of FDI is more than the foreign aids in comparatively open regimes. Borensztein et al. (1998) through the usage of data from sixty nine economies revealed that FDI is a pertinent mode to enhance the economic growth. The study unfolds that the FDI inflows extend the technology to the economies, which has more potent than the internal investment. Chowdhury and Mavrotas (2006) investigate the linkage between FDI and economic growth among the three developing countries -Chile, Malaysia and Thailand from 1969 to 2000.The study employed the Toda-Yamamoto test for causality. The study revealed that GDP leads FDI in Chile, whereas there is bi-directional causality between GDP and FDI in the case of Malaysia and Thailand. Wang and Wong (2009) investigate the relation of foreign direct investment on economic growth through the data of 84 economies from 1987 to 2001. The study makes an endeavor to unfold the varied growth potent of multifarious FDI modes. The study splits the FDI inflows into greenfield and M&As, thereby gauges the effect on the economic growth. The study advocates the green field investment drive the economic growth, whereas the potent of M&As can be garnered through matched level of human capital. de Vita and Kyaw (2009) through the substantial data set of 126 developing countries revealed that positive result of FDI and portfolio investment can be achieved, provided that adequate pedestal of economic development exists in the developing economies. Choe (2003) exhibits the linkage between economic growth and FDI in eighty economies for the time period 1971-95 through the employment of a panel VAR model. The study put forward robust favorable linkage between economic growth and FDI inflows.
Few studies manifest implausible relationship between the FDI and economic growth. In this very vein, studies brought by Griffin (1970), Mansfield and Romeo (1980), Saltz (1992) and Bacic, et al., 2005 manifest resembling conclusion. Bagli & Adhikary (2014) manifest that openness and growth of FDI inflow is insignificant in the assessment of the growth of Indian economy. Nair-Reichert and Weinhold (2001) employed a mixed fixed and random (MFR) panel data estimation to gauge the linkage between the FDI and the economic growth. The study revealed that the linkage between the investment and the economic growth is extremely varied in the sphere of the developing economies. Sarkar (2007) employed panel data analysis to shed apprehension on the linkage between the purported variables. The study indicates that there is no long term linkage between FDI share and growth regardless of the characteristic of economies, in terms of closed or open and poor or rich. De Mello (1999) employed time series and panel data for selected OECD and non-OECD economies for the time span 1970 to 1990 to study FDI led growth. The study concludes that in the case of non-OECD countries, the benefits of FDI led growth are less on account of multiple country specific factors. Irandoust (2001) examines FDI led growth for Denmark, Finland, Norway, and Sweden through the framework of a vector autoregression (VAR) model. The study revealed mixed results for the purported variables. On one hand it unfolds casual relation for Norway and Sweden, whereas the study exhibits no relationship for Finland and Denmark. Haddad & Harrison (1993) through a unique firm level data frame, make an endeavor to investigate the positive spillover effect of foreign investment in the Moroccan manufacturing sector. The study turns down the possibility that foreign investment shall increase the growth in the economy. The study reports that an enhancement in the stock of foreign investment in Malaysia has led to an enhancement in the stock of domestic capital and economic growth. Further the stock of foreign investment hinges on quantum of liberalization of the economy in tandem with the real exchange rate. Hermes & Lensink (2003) underscore the role of financial development as prerequisite for garnering the gains of FDI inflows on the economic growth. The study covering sixty seven countries make an endeavor to examine the contribution of financial development in strengthening the linkage between FDI and economic growth. The study reports that out of the data set, thirty seven economies have adequate financial framework that stimulate FDI to assist favorably to the economic growth .  ISSN 1923-4023 E-ISSN 1923-4031

Data and Variables
This study investigates the linkage among foreign direct investment, financial development and economic growth in Saudi Arabian context from 1970 to 2015. The data is taken from various sources which include International Monetary Fund (IMF) data bank, International Financial Statistics databases, World Bank data set for countries and World Bank GDP estimates. The study has taken GDP per Capita as an indicator for economic growth on account of the fact that it is primarily taken as indicator to measure the growth of economies in the literature. In the lexicon of World Bank, the term Foreign Direct Investment (FDI) is stated in the following manner as "the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, reinvestment of earnings, other long-term capital, and short-term capital as shown in the balance of payments. This series reveals net inflows (new investment inflows less disinvestment) in the reporting economy from foreign investors, and is divided by GDP". In this very vein, the current paper takes in to consideration to gauge the FDI in Saudi Arabian perspective, where the FDI is manifested as a percentage of GDP. As multiples studies have taken Broad Money (M2) as a pointer for financial development. Likewise it is applied in the current study to gauge the financial development.

Augmented Dickey-Fuller (ADF) Test
In order to ascertain the stationary trend of data, unit root tests are employed as these tests assist to avoid specious results due to non-stationarity of data that can disqualify other statistical tests. The study has employed the Augmented Dickey-Fuller test (ADF) test to check the integrated order and behavior of the time series data. The general econometric expression of ADF having a constant and trend is given below. ∆Yt = λ0 +λ1t + λ2 yt-1 +∑ ∆Yt-1 +e t The Equation represents variables in the form of ∆Y t in a time period t, while λ0 is a constant term and ∆Y t = Y t -Yt-1where t represent the trend and et is noise error term used in the model. The results revealed in the above table one reports that the data used for this study are statistically valid as the critical values are more than the t statistics values at level with constant and with the constant linear trend. It manifest that the data is non stationary at level. While the t statistic values are greater than the critical values at first difference with constant and with the constant linear trend that reports that the data are stationary at first difference, thus after addressing the case of unit root, one can go ahead to employ the further tests to ascertain the co integration.

Lag Length Selection
As the VAR model is sensitive to the lag length so the study has utilized the lag length selection yardstick. The majority of the test for lag length selection recommends the lag length 2 as given in the below mentioned table. So the lag length selected for Vector Auto Regression Model (VAR) is 2. This lag length will be applied for other tests as well.

Test for Co-integration
This research paper has employed Johansen and Jueslius (1990) procedure to test for the co-integration among the variables taken under study. The below mentioned tables reveal that Trace test and Max-eigen values are lower than the critical values and the p values for them are also insignificant. It reveals that there is no co integrated equation for the variables. So there is no long run relationship among the variables under consideration. Thus the Vector Error Correction Model (VECM) is not pertinent in the current study.

Granger Causality Test
In order to determine the causal relationship and direction of causality among the variables the Granger causality test has been applied in the paper. The purported test along with the stipulated variables can be modelled in the following basic mode.

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Where ECT t-1 is error correction term at lag order one and are white noise residual and are the intercepts in the above model. The results obtained from the table seven shows the significant facts; first the economic growth measured by GDP per Capita causes the Foreign Direct Investment (FDI), Secondly the economic growth also causes financial development (FD). No Causality is found between Foreign Direct Investment (FDI) and financial development FD.

The Impulse Response Function
Impulse response function is applied to gauge the impact of the shock to the provided variables. Impulse response function manifest the power of a one-time shock to one of the variation on the current and future values of all the endogenous variables under consideration. The mentioned figures reveal the outcome of impulse response on each variables in the form of 3×3 graphs. The above graphs reveal the response of GDP (economic growth) to a shock related with itself and other variable FDI and FD. It is manifested that the response of GDP to itself is a negative change in GDP while in case of Financial Depth and foreign direct investment the response is mostly stable. Response to the shock is positive but FD to GDP while other reaction is generally stable.

Variance Decomposition Method
It is applied for the analysis of a VAR model once it has been tailored. This is a tool to inspect the system dynamics. This method decomposes the variation in an endogenous variable into the component shocks in regard to additional selected variables in the stipulated setup. The significance of the model is on account of reporting about the specific random innovations to the variables in the stipulated setup.  From the above mention tables, it is manifested that 22 percent of GDP can be disclosed by the effects of FDI, whereas it is about 5 percent for the FD. On the other side, 24 percent of FDI can be manifested through the variation in GDP, while it is 1.4 percent with regard to the effect of FD on FDI. In regard to FD, it is manifested that FD are formed upto 53 percent by the effects of GDP and it is only 5 percent in the case of FDI.

Conclusion
This research is an endeavor in order to illuminate and form a link among foreign direct investment, financial development and economic growth in Saudi Arabia for the span covering from 1970 to 2015 by employing modified Granger casualty model. As the outcome of Johansen co-integration test illustrates, no long run co-integration can be recognized among foreign direct investment, financial development and economic growth. VAR model has been applied to gauge the linkage, while the outcome of which demonstrates that there is a link between economic growth, financial development and foreign direct investment. The Granger causality test also confirms that economic growth causes foreign direct investment and financial development which is a unidirectional causality running from economic growth towards foreign direct investment and financial development. No significant causality can be observed empirically between foreign direct investment and financial development. This feature can be attributed to the fact that Saudi Arabian economy is still substantially dependent on its hydrocarbon resources which is the driving force behind the growth. The effect of foreign direct investment is not significant due to fact the economy is still a closed economy, where liberalization measures are still at initial stage. The government has launched Vision 2030 in order to reduce its dependency on oil resources which is expected to leverage the foreign direct investment and financial development, which can eventually have considerable effect on the economic growth. Another reason for the insignificant causality between FDI and economic growth is partly due to equity restrictions. This vision 2030 is expected to enhance the foreign direct investment and financial development in the ensuing years. Thus future research studies in this direction are required in identical economies to substantiate the result of the current study.