FOREIGN TRADE UNIVERSITY

FACULTY OF INTERNATIONAL ECONOMICS

--------***--------

MONEY AND BANKING ASSIGNMENT

Major: International Economics

THE IMPACTS OF MONETARY POLICY ON FOREIGN

DIRECT INVESTMENT INFLOWS OF MIDDLE INCOME
COUNTRIES IN SOUTHEAST ASIA

Credit class : TCHE303CLC.1

Group : 13
Instructor : Msc. Tran Thi Minh Tram

Hanoi, 2021
 INDIVIDUAL ASSESSMENT

Name Student ID Contribution assessment

Nguyen Le Mai Linh 2012450021 100%

Tran Quynh Phuong 2013450236 100%

Nguyen Thao Linh 2014340206 100%

Nguyen Thao Ngoc 2014340208 100%

Pham Viet Hoang 2012340018 70%

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 TABLE OF CONTENT

INTRODUCTION 4
1. Literature review 6
1.1 The concept of monetary policy 6
1.2 The concept of Foreign Direct Investment 7
1.3 Empirical previous research 9
2. Overview of the monetary policy and foreign direct investment of middle
income countries in Southeast Asia 10
2.1 Monetary policy in Southeast Asian middle income countries 10
2.2 FDI in Southeast Asian middle income countries 13
3. Methodology and data 15
4. Empirical model 16
5. Empirical results 17
6. Recommendations and Conclusion 23
REFERENCES 25
APPENDIX 30

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 TABLE OF FIGURES

Table 1. GDP growth (annual %) from 12

2007 to 2009
Table 2. Descriptive statistics 17
Table 3. Correlation matrix 18
Table 4. OLS estimation result 19
Table 5. VIF test 20
Table 6. Ramsey RESET test 20
Table 7. Breusch - Pagan test 21
Table 8. Robust Standard Errors result 21
Table 9. Jacque – Bera test 22

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 INTRODUCTION

Monetary policy refers to the actions taken by the Central Bank to influence the
demand and supply of money in the economy to meet objectives of macroeconomic
variables (Mishkin, 2013). As a result, these measures can be done by operationalizing
monetary policy tools such as changing the money supply, the level and structure of
interest rates, and other circumstances that affect money supply in the economy, such
as changes in GDP and commercial bank capital or liquidity. Interest rates and the
reserve ratio are also important monetary policy tools for achieving economic targets
such as supporting economic growth and development and price stability and inflation
management. (Gregory Mankiw, 2016).

Besides, monetary policy is one of economic policies for providing an attractive

investment environment for Foreign Direct Investment (FDI), which is an essential
element of economic development, through its instruments. However, to the best of
our knowledge, the results of earlier studies on the relationship between monetary
policy factors and foreign direct investment are varied. In terms of interest rates, the
results are uncertain. For example, while Fornah and Yuehua’s study (2017)
demonstrated that interest rates had a positive effect on FDI inflows, others,
specifically, Chingarande (2011) showed that interest rates had no noticeable impact.
In addition, Olweny and Chiluwe (2012) argued that money supply had a positive
influence on foreign direct investment, but Fischer (2013) found that inflation rate was
linked to a large decline in foreign direct investment. The findings of this topic in
previous research are inconsistent because the difference in context leads to the fact
that each country would have different monetary policy and various strategies for
attracting FDI. Therefore, it is important to conduct separate studies on the impact of
monetary policy on FDI regarding specific regions.

FDI plays an important role in developing the economy and monetary policy is
necessary to attract FDI inflows (International Monetary Fund, 1999). There was a lot
of research in the relationship between monetary policy and Foreign Direct Investment
but none of them studied this relationship in middle income countries in Southeast
Asia. Therefore, we decided to carry out a study by evaluating the impact of monetary
policies on foreign direct investment inflows of five middle income countries in
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Southeast Asia, namely Vietnam, Indonesia, Thailand, Malaysia and Philippines
during the period of 2004-2019. The outcomes of this study will assist to solve some
of the stated concerns surrounding the topic of research by empirically determining the
relationship between monetary policy and foreign direct investment. For policymakers
to make decisions, they must recognize the relationship between monetary policy and
foreign direct investment. As a result, the goal of this research is to assist policymakers
in making decisions by providing a clear reference on how monetary policy affects
foreign direct investment, and determining the causal relationship between five
Southeast Asian middle-income countries’ monetary policy and foreign direct
investment.

Implicitly the critical questions raised are: Does monetary policy have an effect on
foreign direct investment inflows of the middle income countries in Southeast
Asia? And what are the indicators affecting them?

The plan of the report is organized as follows. Section 1 briefly discusses the literature
review, whereas Section 2 overviews monetary policy and FDI inflows of middle
income countries in Southeast Asia. The methodology and data are illustrated in
section 3. The empirical model is specified in Section 4. Then Section 5 shows our
analysis. Finally we give recommendations and conclude the paper in section 6.

We would like to express our sincere gratitude to Msc. Tran Thi Minh Tram, our
teacher, who helps us to complete the report with useful advice and gives us
knowledge to learn and to experience.

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1. Literature review
1.1 The concept of monetary policy
According to Thierry Warin (2005), monetary policy is the process of overseeing a
nation's money supply to complete specific objectives such as restraining inflation, or
achieving full employment. Monetary policy can adjust interest rates, require margin,
capitalize standards for banks, and act as the lender of last resort. Monetary policy
strives to achieve a number of goals, including: 1) monetary stability and economic
growth; 2) monetary growth organization; 3) a satisfactory level of foreign
investments; and 4) maintaining the national currency's value and exchange reserves
(Mustafa, 2012).

To implement monetary policy in the economy, three tools are operated by the Central
Bank: Changing reserve requirements; Changing the discount rate and Open market
operations. Change the legal reserve requirement, which is the portion of bank deposits
held by the central bank. The central bank adjusts deposits in response to the state of
the economy (Hasheesh, 2012; Fahmy 2006). The discount rate is the interest imposed
by the central bank to commercial banks. When commercial banks rediscount their
securities and trade in the central bank, it allows them to extend credit more easily
(Corporate Finance Institute, 2015). The operation of open markets is the main tool of
monetary policy. This involves overseeing the amount of money circulating through
the buying and selling of a variety of credit instruments, foreign currencies, or
commodities, which can result in more or less base currency going in or out of the
circulation. Achieving a certain short-term interest rate target is a short-term purpose
of open market operations. Instead of targeting interest rates notwithstanding,
monetary policy might comprise aiming a specified exchange rate relative to some
foreign currency, or else relative to gold (Thierry Warin, 2005).

Athanasios Orphanides and Volker Wieland (2013) stated that monetary policy was
applied to maintain price stability and economic stability. That is, the central bank is
tasked with keeping inflation low and constant, compatible with the central bank's
notion of price stability, and avoiding major macroeconomic changes. And to achieve
the effectiveness of monetary policy, Athanasios and Volker considered the main
indicators of monetary policy in relation with macroeconomic dynamics, especially

6
output and inflation that were built and estimated over the years by researchers at the
European Central Bank and other central banks and at universities, the International
Monetary Fund, and the European Commission.

Sanna Olsson and Gustaf Jungnelius (2019) conducted their research on monetary
policy in Sweden. They found that on a macro level, to control monetary policy, it is
important to first consider its theoretical framework’s pillars, from macroeconomic
theory to interest rates and the link to global markets. The Central Bank indirectly
raises or lowers interest rates by increasing or decreasing the money supply in the
economy. Overtime, specific monetary policy instruments, such as the Taylor Rule,
have evolved to allow central banks to respond to macroeconomic developments in a
proactive manner. In the meantime, when considering controlling monetary policy in
relation with the repo rate, the main tool of monetary policy, the focus is to keep
inflation at a reasonable level (Sveriges Riksbank, 2019).

1.2 The concept of Foreign Direct Investment

The term Foreign Direct Investment refers to a foreign entity owning a domestic asset
(World Investment Report, 2007). FDI is described as investment from one country
into another that entails the establishment of activities or the acquisition of tangible
assets, including shares in other enterprises (Financial Times Lexicon, 2019). While
the overarching term can include government investments, FDI usually refers to
private investments.

The importance of foreign direct investment can be linked to its function in

establishing long-term networks between nations, making it a key component of
international economic integration (OECD I Library, 2019). Technology transfers
between countries are one positive spillover of FDI, acting as a significant accelerator
for economic progress. Although past studies (Demirhan and Masca, 2008; Bagli et al.,
2014) have been made to determine the fundamental factors of FDI, no consensus
appears to have been established. There is currently no unifying theory that
definitively specifies the determinants of FDI flows from one country to another,
whereas there are some intriguing approaches to this problem (REENU KUMARI,

7
Anil Kumar Sharma, 2014). There are certain ideas on the subject of the factors of FDI
that differ in their conclusions.

Asiedu (2002) looked at thirty-four countries in Sub-Saharan Africa between 1980 and
2000. She discovered that higher income, trade openness, infrastructure, and
institutional framework were found with increasing foreign investment based on panel
data analysis. On the basis of a set of panel data belonging to twenty nations for the
period 1984-2000, Asiedu (2006) further proved that big market size and natural
resources encouraged FDI inflows.

Chanin Mephokee and Anuwat Cholpaisan (2011), when looking at the FDI inflows in
Thailand and Vietnam, found that GDP per capita, real interest rate, degree of
openness, and exchange rate were the elements that can explain as leading indicators
for FDI. The level of openness was considered to be the most important factor whilst it
was GDP which had no effect on FDI.

Erdal Demirhan, Mahmut Masca (2008) conducted a study into FDI inflows in the
Southeast European developing countries. This study gave the results that the factors
of FDI were mainly macroeconomic elements namely economic stability, growth,
inflation, trade openness, market size and infrastructure. The same result as the study
of Chanin and Anuwat (2011) occurred when GDP showed no impact, while openness
and inflation gained high significance.

Buchanan et al (2012) looked at the impact of institutional quality on FDI levels and
volatility using panel data in a recent study. They provided new evidence that
educational institution quality influenced FDI in a positive and significant way.

A remarkable number of studies have been conducted on significance and

determinants of FDI. However, little study has been done on the relationship between
FDI and its determinants in developing nations (REENU KUMARI, Anil Kumar
Sharma, 2014). In the meantime, many developing countries, especially those in
South, East, and Southeast Asia, are working to boost FDI inflows. Thus, delving into
the controversial factors of FDI and building research on the concept of FDI are
important.

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 1.3 Empirical previous research

Mukhtarov, Mohammad, Azizov and Jabiyev (2020) investigated the impact of money
supply, interest rate and tax revenue on FDI in the case of Jordan during the period of
1991-2017 by using the Vector Error Correction (VECM), Canonical Correlation
Regression (CCR) and Fully Modified Ordinary Least Squares (FMOLS) techniques.
The result showed that money supply is significant with a positive sign, a 1% rise in
money supply increases FDI by 4.75%, the impact of interest rate on FDI is
statistically insignificant and the effect of the tax revenues statistically significant with
a negative sign at 1% level.

The research of Fornah and Yuehua (2017) aimed to identify the effect interest rate has
on FDI inflows to Sierra Leone from 1990 to 2016 based on five important indicators,
which are real interest rate, trade openness, GDP growth, inflation rate and exchange
rate, by using the ordinary least square (OLS) estimation. The study revealed that real
interest rate, trade openness and GDP growth positively influences FDI inflows into
the economy and is statistically significant. The rate of inflation, which is used as a
proxy for the indicator of economic stability, in Sierra Leone negatively impacts FDI
and is statistically significant. Exchange rate also has a negative impact on FDI.
However, it is statistically insignificant in the short run model.

Sabah, Anwaar and Daghr (2020) concluded that the monetary policy has affected FDI
in Iraq during the period from 2004 to 2017. The legal reserve as a monetary policy
tool has had a considerable impact on FDI in Iraq. Furthermore, the growth rate of
money in circulation as a measure of the Iraqi Central Bank's monetary policy has had
no considerable impact on FDI in Iraq throughout this period . Both monetary policy
instruments, the rediscount rate and open market operations, have had no meaningful
impact on FDI in Iraq. During the study period, both the growth rate of the quantity of
money in circulation and FDI are co-integrated.

Murwani, Sriyanto & Lestari (2019) conducted a study on the role of monetary policy
for supporting Foreign Direct Investment Inflows in Indonesia. Data ranged from 2000
until 2019 and included a four-variable VAR, which are FDI, exchange rate, interest

9
rate, and inflation. The purpose of this study was to show which variables had the
highest effect on FDI fluctuation. Except for inflation rate, other factors affected FDI.

Khalid and Selemad (2018) examined the relationship between macroeconomic

policies and foreign direct investment in Malaysia. This study used OLS regressions
method to test the significant impacts and the results revealed that only government
spending and reserves money had significant impacts towards FDI. However, the
empirical results of the study indicated that in the long run, government spending, tax
revenue, reserves money and broad money are the Granger cause for the foreign direct
investment. Earlier study of Ellyne M.J (2009) in the case of Madagascar also showed
a similar finding.

The study of Magdalena, Elena and Abdelnaser (2012) for Romania indicated that the
most important factor that positively influences FDIs is the monthly real active interest
rate of commercial banks. Monthly inflation rate, monthly export and the minimum
reserves ratio also positively impact on FDIs . In contrast, the monthly variation of the
direct fiscal taxes has a negative effect on FDIs. Gustaf Jungnelius and Sanna Olsson's
study (2019) for the case of Sweden showed that there was not a link between
Sweden’s repo rate (policy interest rate) and its FDI inflows. However, Sweden’s
monetary policy has affected foreign investments. More specifically, the negative
interest policy implemented in 2015 had an effect on net FDI inflows.

The previous research findings on this topic are conflicting. Each country with a
different background has a different monetary policy to attract more FDI inflows. As a
result, independent studies to assess the impacts of monetary policy on FDI in specific
regions are necessary.

2. Overview of the monetary policy and foreign direct investment of middle

income countries in Southeast Asia
2.1 Monetary policy in Southeast Asian middle income countries
For a stable developed national economy, the government must have flexible
management and durable macro-regulatory tools. One of the most important tools is
monetary policy (Rajah Rasiah, Kee Cheok Cheong, Richard Doner, 2014). We found
that monetary policy and the banking system are as important to the economy as the

10
vascular system of a living organism, to countries in the world, and especially to the
group of five Southeast Asian countries: Vietnam, Thailand, Indonesia, Malaysia,
Philippines. The above countries are rather similar in the characteristics of
geographical location, climate, people and especially in their economic development
policies: monetary policy was tightened or loosened, how to use tools of monetary
policy to suit each period, when the market is stable, crisis or post-crisis.

Before the 2008 financial crisis, the Central Bank of these countries applied a tight
monetary policy, considering it an important part of the group of solutions to stabilize
the economy (Rajah Rasiah, Kee Cheok Cheong, Richard Doner, 2014). For example,
in Vietnam, monetary policy was tightened through a series of strong and continuous
measures. The State Bank of Vietnam stopped buying foreign currencies at the end of
2007 when the inflation trend in our country increased. Then in early 2008, the State
Bank issued compulsory bank bills to reduce liquidity in Vietnam dong in the banking
system and at the same time applied a ceiling deposit interest rate. As a result, credit
growth dropped sharply and raised concerns about the risk of liquidity shortfall in
June-July. Meanwhile, driven by rising food prices, strong economic activity, declining
real interest rates, and a slightly weaker rupiah, rising inflationary pressures are posing
a major challenge for Indonesian monetary policy in the middle of 2007. While
inflation remained within the target range at end-2007, it had been accelerating in
2008. As a result, in 2008, Bank Indonesia had been gradually tightening monetary
policy.

In response to the 2008 financial crisis, the Vietnamese State Bank issued a decision to
encourage commercial banks to focus on providing credit for production, agriculture
and rural development, export and import, imports of essential goods as well as small
and medium enterprises. Besides, in December 2008, the Monetary Policy Committee
(MPC) of Thailand decided to lower the policy interest rate by 1.00 percent per
annum, from 3.75 to 2.75 percent per annum. The MPC assessed that monetary policy
could be eased to help support economic recovery, particularly as the economy faced
numerous adverse risks from both on domestic and external fronts (BOT News
No.44/2551).

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In the period from 2008 to 2010, after the crisis, the tightening of monetary policy also
caused aggregate demand to decline, leading to slow economic growth.
Table 1. GDP growth (annual %) from 2007 to 2009

Indonesia Malaysia Philippines Thailand Vietnam

2007 6.35% 6.3% 6.52% 5.44% 7.13%

2008 6.01% 4.83% 4.34% 1.72% 5.66%

2009 4.63% -1.51% 1.45% -0.69% 5.4%

Source: World Bank
According to the above table, all five countries' GDP growth fell. The sharp decrease
was Malaysia, Thailand and the Philippines, while Vietnam and Indonesia were less
affected. Therefore, governments of many countries began to loosen monetary policy
from 2008 to 2010 to stimulate economic growth.

From 2010 to 2011, then the monetary policy tightened again to stabilize the
macro-economy, and to control inflation. In the Philippines, Economic activity slowed
down during the first three quarters of 2011. Financial conditions have remained
supportive of growth. The authorities have unwound crisis-related liquidity support
measures and started to tighten monetary policy since March 2011. In Malaysia,
monetary policy in the first half of 2011 was therefore focused on the need to further
normalize interest rates and on the need to pre-emptively respond to the risks to
macroeconomics. In the second half of the year, however, the downside risks to
domestic economic growth increased significantly due to deteriorating financial
conditions, whereas the upside risks to inflation had begun to moderate.

During 2012, core inflation was under control but economic growth showed signs of
slowing down. Therefore, from 2012 to 2019, monetary policies in these countries
were gradually loosen to promote economic growth in the context of controlled
inflation.

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In conclusion, basically, the above mentioned period witnessed common ground on the
controlling of monetary policy of the governments in these five Southeast Asian
countries. After the crisis, countries became more careful in tightening or loosening
monetary policy. Monetary policy since 2014 has operated in a proactive and flexible
manner, closely coordinating with fiscal policy and other macroeconomic policies in
order to control inflation according to the set target, stabilize the macro-economy and
stabilize the economy, and contribute to support the economic exchange rate at a
reasonable level.

2.2 FDI in Southeast Asian middle income countries

Investment is used to drive the domestic economy in developing countries. It can be
done through direct investment or indirect investment. Azam (2011) stated that the
developing countries should keep economic and political stability, infrastructure
availability, peace, and security, and increase international trade as these measures can
be used to promote FDI inflows from developed countries.

The development of FDI tended to fluctuate but with an increasing trend. The
development of FDI in ASEAN-6, including Vietnam, Indonesia, Thailand, Malaysia,
Singapore and Philippines, from 2006 to 2014 was between US$18.5 million and
US$25 million. This indicates that FDI is an important economic indicator for the
domestic economy in ASEAN, and specially five countries above (Diella Rahmawati
Fazira, Malik Cahyadin, 2018).

Five middle-income countries in Southeast Asia had effective policies to attract

foreign direct investment. It was one of the first emerging regions to welcome FDI as
part of a strategy of export-led development (OECD, 2018). And as a result, we found
that its shares both of emerging market FDI inflows and of global exports grew
quickly in the period between the currency realignments. And all middle income
countries in the region have benefited from the growth in FDI inflows (Bich Ngoc,
2020).

Thanks to favorable and open policies and efforts to improve the business investment
environment, especially political stability, Vietnam has created its own attraction and

13
become an attractive investment destination, sought after by many foreign enterprises.
According to the study of Sajid Anwar and Lan Phi Nguyen (2010), by making use of
a recently released panel dataset which covers 61 provinces of Vietnam during the
period of 1996–2005, it was found that the direct effect of FDI on economic growth in
Vietnam is positive, the indirect effect through the economy’s absorptive capacity was
found to be negative. While the proportion of US Outward Foreign Direct Investment
(OFDI) in ASEAN four countries, including Indonesia, Malaysia, Thailand and the
Philippines, decreased from 2009 to 2019, this proportion has remained almost
unchanged in Vietnam. This was a positive signal for Vietnam to promote attracting
FDI from the world's leading economy.

According to statistics from the World Bank, in 2018, the amount of FDI inflows to
Thailand was relatively positive, over 13 billion USD, nearly double that of 2017. The
Thailand government set a target to attract a series of foreign investment projects, with
a total value of up to 24 billion USD in 2019. To achieve that goal, in September 2019,
Thailand approved the Thailand Plus preferential policy package. Accordingly, foreign
enterprises investing in Thailand will receive a 50% reduction in corporate income tax
for 5 years, a double discount on training costs and a corporate tax exemption for 5
years when established skills development bases.

Since 2014, by applying a series of policies to reform the economy and attract FDI,
Indonesian FDI inflow has had spectacular growth. From the rather modest figures of
the previous years, in 2015 and 2016, Indonesia received a huge FDI inflow of 29.3
billion USD and 29.75 billion USD, respectively. However, FDI inflows into the
country decreased and only reached 22 billion USD in 2018 (UNCTAD statistics). In
2019, FDI into Southeast Asia increased sharply, but did not go to Indonesia. More
broadly, FDI in the manufacturing sector in Indonesia has been shrinking since 2018.

Malaysia has also made breakthroughs in attracting FDI and has received
well-rewarded results. Looking back from 2011 to 2016, this time Malaysia
continuously conquered new heights in FDI attraction, but this capital inflow tends to
flow more slowly in the following years. According to Statistics Malaysia, the amount
of FDI into the country decreased from nearly 11.6 billion USD in 2016 to 10.08
billion USD in 2017, down 12.77% compared to the previous year. In 2018, this
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number continued to decline sharply, only about 8 billion USD. While FDI attraction
tends to decrease and friends in the region continuously have new policies to attract
foreign investors, Malaysia has made strong efforts to improve its attractiveness to
foreign investors by offering tax incentives, along with efforts in expanding
manufacturing and service industries and promoting the digital economy. In 2019, the
amount of FDI into the country reached $7.1 billion, up 73.4% over the same period
and nearly equal to the figure of the whole of last year.

The average annual foreign direct investment inflows into the Philippines are still
limited compared to other countries in Southeast Asia because the country's
infrastructure is still backward and has not met the requirements of investors
(Metropolitan Bank & Trust Co, 2019). In the period from 2000 to 2012, on average,
the Philippines attracted about 1.55 billion USD of FDI each year, much lower than
Thailand's average of 7.2 billion USD; Indonesia is 6.2 billion USD; Malaysia is 5.88
billion USD and Vietnam is 4.54 billion USD (Metropolitan Bank & Trust Co, 2019).

Foreign Direct Investment is an important part of a country’s economic development

and serves as a growth mechanism. It is particularly the case for developing countries
where companies need funding and the government is enforcing the process of
expanding internationally and economically. Compared with other middle-income
countries in other regions, promising results in attracting FDI inflows are observed in
these Southeast Asian middle-income countries as considerable attempts have been
made, however it is still in a primitive stage of development. Therefore, it is
imperative to delve into the factors affecting FDI in these five countries in relation to
national policies and development.

3. Methodology and data

The study used panel data from five middle income countries in Southeast Asia
(namely Vietnam, Thailand, Indonesia, Malaysia, Philippines) in 16 years between
2004 and 2019. All the secondary data were obtained from the World Bank
Development Indicator. To examine the impacts of monetary policy on FDI inflows,
we chose four explanatory variables which are broad money (BM), real interest rate
(IR), total reserve (TR) and exchange rate (ER).

15
Ordinary Least Squares (OLS) method is applied to estimate the parameters of a
multivariable regression model. In order to make our model free from the problems,
we carried out the following diagnostic tests: Correlation matrix and VIF variance
testing for multicollinearity, F-test to test the significance of variables in the model,
Resset’s Ramsey method to check omitted variables, Breusch – Pagan method to test
heteroskedasticity, Robust Standard Errors to obtain unbiased standard errors of OLS
coefficients under heteroscedasticity, Jacque – Bera method to test for normality of
observations and regression residuals. All of them were run by STATA software.
4. Empirical model
By OLS method, the model was specified to determine the relationship between FDI
inflows and four independent variables as follow:
𝐹𝐷𝐼 = β0 + β1𝐵𝑀 + β2𝐼𝑅 + β3𝑇𝑅 + β4𝐸𝑅 + µ

Where FDI is foriegn direct investment measured by % of GDP; BM is broad money

(% of GDP); IR is the interest rate; TR is total reserve (billion US); ER is the exchange
rate (LCU per US) and µ is an error term, which captures other factors that may cause
the variation in dependent variable but not included in the model.
Foriegn Direct Investment inflow (FDI) is individually considered as a dependent
variable for the purposes of our study.
Broad money (BM) is the total amount of currency outside banks; demand deposits
other than those held by the central government; the time, savings, and foreign
currency deposits of resident sectors other than the central government; bank and
traveler’s checks; and other securities (World bank). In the research about the impacts
of monetary policy on FDI in Malaysia during the period from 1997 to 2016 by Khalid
and Selemad (2018), broad money was concluded not to influence FDI due to the
much greater than 0.1 probability value.
Real interest rate (IR) is a proxy for monetary policy. Faroh and Shen (2015) showed
that the coefficient on interest rates in Sierra Leone is not significant at 1% level with
unexpected negative sign, which means it is not a key factor explaining the variability
of FDI flows. The same result that the impact of interest rate on FDI is statistically
insignificant was pointed out in empirical study on Jordan (2020) where there is no
developed financial system. In contrast, Kennedy Ocharo (2018) concluded that the

16
real interest rate has a negative and significant influence on foreign direct
investment inflows to Kenya.
Total reserve (TR) comprise holdings of monetary gold, special drawing rights,
reserves of International Monetary Fund (IMF) members held by the IMF, and
holdings of foreign exchange under the control of monetary authorities (World bank).
Khalid and Selemad (2018) highlighted that reserve money has a significantly positive
effect on Malaysian FDI inflows, which is consistent with the study’s results in
Madagascar (Ellyne M.J, 2009).
Exchange rate (ER) refers to the exchange rate determined by national authorities or
to the rate determined in the legally sanctioned exchange market. It is calculated as an
annual average based on monthly averages (World bank). Joseph, Donghyun, and
Wang (2009) highlighted that under a favorable FDI environment, the exchange rate
has a positive and significant effect on the average rate of FDI inflows when they
studied in the United State. There is a significantly positive relationship between
exchange rate and FDI in Sweden (Olsson and Jungnelius, 2019). Additionally,
exchange rate was considered as a key determinant of FDI inflow in Sierra Leone as
higher exchange rate leads to FDI increase (Faroh and Shen, 2015).

5. Empirical results
Table 2. Descriptive statistics

Variables Obs Mean Std.dev. Min Max

FDI 80 3.087 1.938 0.057 9.663

BM 80 92.947 38.2 36.002 164.868

IR 80 2.965 3.527 -6.553 11.782

TR 80 85.003 51.596 7.041 224.356

ER 80 6089.952 8085.97 3.06 23050.24

Source: STATA
Table 2 offers descriptive statistics of the variables included in our analysis. All
variables have 80 observations, which are collected from the data of five middle

17
income Southeast Asian countries, namely Vietnam, Thailand, Indonesia, Malaysia
and Philippines.

The variables BM, TR and ER show a high level of standard deviation, respectively
38.2, 51.596 and 8085.97. This means these variables are much spread out from their
mean. All variables also have a wide disparity between min and max values, which
implies that there are big differences in collected data among these given countries and
the values fluctuate throughout the given time.

The dataset of interest rate is the only one that contains negative values. Negative
interest rates policy is considered as a way to revive lending (Gregory Mankiw, 2009).
In other words, when money is put on deposit, the bank will charge interest from
depositors. This results in encouraging investment and spending instead of hoarding
money. In the past, this extraordinary policy was imposed by the European and
Japanese central banks when they had been experiencing the 2008 financial crisis.

Table 3. Correlation matrix

FDI BM IR TR ER

FDI 1.000

BM 0.489 1.000

IR -0.309 -0.147 1.000

TR -0.345 0.237 0.175 1.000

ER 0.546 -0.045 0.08 -0.474 1.000

Source: STATA
In econometrics theory, the correlation matrix determines the correlation coefficients
between independent variables in a model. Multicollinearity is said to exist when the
explanatory variables are substantially correlated to each other.

18
From the table, it can be observed that the dependent variable FDI and independent
variables BM, IR, TR, ER show the magnitude of low correlation with the values
extracted from running Stata 0.489, -0.309, -0.345, 0.546 respectively. These results
indicate a weak linear relationship via a shaky linear rule and that there is no
multicollinearity between variables. In the case of independent variables, the
correlation among variables is not high. All the variables have values less below 0.5
meaning that no strong relationship exists between them and that it shows the absence
of multicollinearity here.
Table 4. OLS estimation result

Variable Coef Std t test P value

BM 0.0265 0.0036 7.39 0.000

IR -0.1417 0.042 -3.37 0.001

TR -0.0072 0.003 -2.33 0.022

ER 0.00012 0.00002 6.41 0.000

cons 0.9313 0.4326 2.15 0.035

Obs 80

F(4,75) 37.39

Prob>F 0.0000

𝑅
2 0.666

Adj 𝑅
2 0.6482

Root MSE 1.1492

Source: STATA
Based on the results of the OLS regression test in table 2 above, all independent
variables are significant at 1% level except that total reserve has a 5% level of
significance.

19
 2
The coefficient of determination (𝑅 = 0. 666) shows that the independent variables
explain 66.6% of the total variance of the dependent variable. The remaining 33.4%
belongs to other factors affecting the FDI variable. The F statistic of Prob > F = 0.0000
shows that the model is correctly specified and the independent variables correctly
explain the dependent variable.
Diagnostic test
To test exactly the presence of multicollinearity, we use Variance Inflation Factor VIF.
When using the vif command in STATA software, we have the following results:
Table 5. VIF test

Variable VIF 1/VIF

BM 1.12 0.894

IR 1.12 0.892

TR 1.50 0.668

ER 1.36 0.738

Mean VIF 1.27

Source: STATA
It can be seen from the table that all VIF values are less than 2.00 which means no
multicollinearity is recorded.
To correctly specify our linear regression model, whether it contains unnecessary extra
variables, it is missing an important variable or there is functional form
misspecification, we use Regression Specification-Error Test by Ramsey (1969).
Using ovtest command in STATA software, we have:
Table 6. Ramsey RESET test

Ramsey RESET test using power of the fitted values of FDI

𝐻0: 𝑚𝑜𝑑𝑒𝑙 ℎ𝑎𝑠 𝑛𝑜 𝑜𝑚𝑖𝑡𝑡𝑒𝑑 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠

𝐹(3, 72) = 1. 90
𝑃𝑟𝑜𝑏 > 𝐹 = 0. 1376

Source: STATA

20
Using a significance p-value of 1%, the RESET test is not significant. The null
hypothesis is not rejected. This means no omitted variables are present in the model
and thus doesn’t cause model misspecification.

Breusch - Pagan Test was introduced by Trevor Breusch and Adrian Pagan in 1979. It
is used to test for heteroskedasticity in a linear regression model and assumes that the
error terms are normally distributed. It tests whether the variance of the errors from a
regression is dependent on the values of the independent variables. By using this
method, we have following results:
Table 7. Breusch - Pagan test

Breusch - Pagan test for heteroskedasticity

𝐻𝑜: 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒

Chi2(1) = 7.17
Prob > chi2 = 0.0074

Source: STATA
At the 1% significant level, we have Prob > chi2 = 0.0074 < 0.01. Therefore, the null
hypothesis is rejected. This concludes that the data is heteroskedastic. To fix this
problem, the Robust Standard Errors is used with the following results.
Table 8. Robust Standard Errors result

Variable Coef Robust Std t test P value

BM 0.0265 0.0031 8.55 0.000

IR -0.1417 0.0656 -2.16 0.034

TR -0.0072 0.00296 -2.42 0.018

ER 0.00012 0.000018 6.72 0.000

cons 0.9313 0.3945 2.36 0.021

Source: STATA

21
As such, the estimated coefficient of the regression model is unchanged, however, the
error of the estimate has been reduced to its strong standard error, thereby resolving
the heteroskedasticity.

To determine the normal distribution of the data set, we calculate skewness and
kurtosis. Skewness is a measure of the symmetry in a distribution. Skewness
essentially measures the relative size of the two tails. Kurtosis is a measure of the
combined sizes of the two tails. The results from STATA software shows:
Table 9. Jacque – Bera test

Variable Obs Pr(Skewness) Pr(Kurtosis) Adj (2) Prob>chi2

res 80 0.0211 0.0576 7.93 0.0189

Source: STATA
From STATA, we have Pr(Skewness) = 0.0211, implying that skewness is
asymptotically normally distributed (p-value of skewness > 0.01). Similarly,
Pr(Kurtosis) = 0.0576 indicates that kurtosis is also normally distributed (p-value of
kurtosis > 0.01). Lastly, chi2 is 0.0189 which is greater than 0.01 implying its
significance at a 1% level. Consequently, the null hypothesis cannot be rejected.
Therefore, according to the Skewness/Kurtosis test for normality, residuals show
normal distribution.

After testing and resolving, the model is specified as follow:

𝐹𝐷𝐼 = 0. 9313 + 0. 0265𝐵𝑀 − 0. 1417𝐼𝑅 − 0. 0072𝑇𝑅 + 0. 00012𝐸𝑅 + µ

Broad money (BM)
Unlike the results performed in the study on Malaysia (Khalid and Selemad, 2018), the
coefficient of broad money is significant at 1% level with positive sign. This indicates
that FDI inflows rise by 0.0265 units as broad money witnesses a 1 unit increase.
Real interest rate (IR)
Real interest rate is a key factor negatively influencing FDI inflows in five Southeast
Asian countries, which is a coincidence with the result found in Kenya and contrastive
to the results in Sierra Leone, Zimbabwe and Jordan where FDI inflows are not

22
significantly affected by real interest rate. Specifically, when the real interest rate
decreases by 1 unit, FDI inflows go up by 0.1417 units.
Total reserve (TR)
Like the real interest rate, total reserve also has a negative impact on FDI inflows.
With each 1 unit decrease in total reserve, FDI inflows are expected to go up by 0.0072
units.
Exchange rate (ER)
In terms of exchange rate, it has a positively small effect on FDI inflow when each unit
increase leads to higher FDI inflow with rising by 0.00012 units. This result is
supported by previous empirical studies by Joseph, Donghyun, and Wang (2009),
Olsson and Jungnelius (2019), Faroh and Shen (2015). However, this result is
inconsistent with Chingarande A. (2011) who indicated the variability of exchange
rate in Zimbabwe does not affect FDI.

6. Recommendations and Conclusion

Based on quantitative analysis, we conclude that the monetary policy does affect FDI
inflows in middle income countries in Southeast Asia. All the independent variables of
the study are statistically significant to Foreign Direct Investment in Indonesia,
Malaysia, Philippines, Thailand and Vietnam from 2004 to 2019. While broad money
and exchange rate have positive effects on FDI inflows, real exchange rate and total
reserve have negative impacts.
The findings of this study have important implications for middle income countries in
Southeast Asia to attract more FDI inflows. It is suggested that the Central Bank in
these countries should determine the obstacles that limit the effectiveness of monetary
policy and remove them to attract FDI inflows. In addition, monetary policy tools
should be properly applied to increase investment capital. First, the real interest rate is
an effective tool that can be the main driver of FDI growth, so the policymakers should
reduce it because of the inverse relation with FDI inflows. Second, Expansionary
Monetary Policy will be a better option to be implemented since increasing broad
money and decreasing total reserve can enable these countries to encourage the
attraction of FDI. Finally, even though the exchange rate does not give a high impact

23
in influencing the foreign direct investment, it is essential to take into account this
monetary policy tool.
There are limitations that occurred upon completing this report. While some
relationships to FDI follow theories and previous studies, others do not. This can be
the issue of missing data and the sample size. However, we believe that the entire
amount of data obtained allowed us to complete the analysis. As for the
recommendation, future researchers should have better access to data associated with
these tools and consider more variables, such as inflation rate, open market operations,
and other methods such as generalized least squares (GLS) method, weighted least
squares (WLS) method to analyze so that the evaluation will be more appropriated.

24
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APPENDIX

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31