Impact of Foreign Direct Investment on

Economic Growth in Afghanistan

Mohibullah Faqeerzai & Abdul Ahad Samad

Da Afghanistan Bank

Monetary Policy Department

Economic Research Team

December, 2020
Abstract

This paper studies the relationship between foreign direct investment and economic growth
in Afghanistan using time series data for the period 2008-2019. The causality tests have
been applied to the data and the results confirm there is no causality between the variables
due to political uncertainty, unstable and volatile economic conditions of the country,
security conditions, continued war, and withdrawal of foreign troops.

2
Contents
1. Introduction: ................................................................................................................................... 4
2. Literature Review ........................................................................................................................... 6
3. Theoretical Framework: ................................................................................................................. 8
4. Data and Methodology: ................................................................................................................ 10
Model Specification .......................................................................................................................... 10
5. Data Analysis and Interpretation................................................................................................. 11
Descriptive Statistics .................................................................................................................... 11
Correlation Matrix ....................................................................................................................... 11
Factors affecting Foreign Direct Investment: ..................................................................................... 15
Causality results ........................................................................................................................... 18
6. Conclusion and Policy Recommendations ................................................................................... 19
7. References ..................................................................................................................................... 21
8. Appendix ....................................................................................................................................... 23

3
 1. Introduction:
Afghanistan, a landlocked country located in the central Asia with a strategic geographical
position connects important trade routes of southern and eastern Asia to Europe and the
Middle East.

Since 2001, Afghanistan has witnessed remarkable economic growth with creating new
opportunities for business and employment in the country. After several years of high
economic growth, growth declined to average 2 percent per year from 2013 onwards,
largely due to the withdrawal of foreign troops and decrease in international assistance. The
growth in Afghanistan has been volatile as it is more reliant on agriculture (around 25% of
GDP) which is affected by the weather condition in the country. Gross Domestic Product
(GDP) surged from USD 2.2 billion in 2002 to around USD 21 billion with services sector
accounting for half and agriculture and industry for the second half being three major
sectors of the economy. Since 2001, the government has built basic infrastructure including
roads, trade ports, electricity, and railways to support the economy.

Though, Afghanistan ranks among the lowest exporting economies, its exports have grown
strongly from a very low base in 2001. Afghanistan has signed several free trade
agreements within the region and also become the member of WTO gaining access to a
number of large markets in the developed world including United States of America and the
Europe. The government has also adapted the strategy to support infant industries such as
flexible tax and duty regime, provision of cheap land for a specific period of time, and tariff
protections. Afghanistan’s minerals and other extractive resources worth more than USD 3
trillion are yet to be explored and extracted.

Since 2001, foreign assistance has become most important source of capital which has
contributed to the economic growth of Afghanistan. Yet, above 50 percent of the Afghan
population live in poverty. To lift more than half of the country’s population out of poverty,
the country has to maintain a steady growth rate; therefore, it is important to focus more on
investment and growth enhancing sectors which include investment in agriculture, mining,
energy, infrastructure, industry, telecommunication, and service sector.

In order to achieve economic growth targets, the government of Afghanistan is trying to

create a favorable investment environment through introducing new economic policies,
incentives for investors, adoption of pro-private sector stance, liberal trade regime and etc.
as it plays an important role in the development process of the country.

4
There has been a large body of literature on the impact of FDI on economic growth and it
has been identified that it plays an important role in the development of developing
countries.

This paper investigates the role of foreign direct investment in the economic growth and
points out financial constraints in Afghanistan.

It is important to discuss the trend of FDI and GDP in Afghanistan. Since 2001,
Afghanistan’s gross domestic product saw an unprecedented growth. The economy of
Afghanistan has had significant improvement due to the infusion of billions of dollars. The
Gross Domestic Product in Afghanistan skyrocketed from around 1 billion USD before
2001 to 20 billion USD in 2019. Furthermore, the average annual growth rate of
Afghanistan is about 3 percent.

Figure 1.1.

GDP of Afghanistan (in Mn US$)

25000.00

20000.00

15000.00

10000.00

5000.00

0.00

Source: NSIA Afghanistan

5
Figure 1.2.

Net FDI inflows in Afghanistan (in Mn US$)

250.00

200.00

150.00

100.00

50.00

0.00
2008/09 2009/10 2010/11 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20

Source: BoP, DAB

After reaching its lowest level in 2017 (USD 12.9 million), FDI inflows have been
increasing gradually. The figures after 2017 are still low compared to the inflow levels the
country received before 2009 (with a high of USD 197.5 million in 2009) as a significant
share of FDI was linked to the intervention of NATO armed forces and associated
development projects.

The rest of the paper is organized as follows: section two discusses the literature review,
section three theoretical framework of FDI, section four discusses the empirical part,
including the data, model specification, and methodology; section five reports and discusses
the empirical results; finally, conclusions and recommendations.

2. Literature Review
Foreign Direct Investment means a direct investor (nonresident) gets an interest of at least
ten percent in an enterprise located in home country (resident). Since Foreign Direct
Investment is a form of investment, it impacts the current account balance, gross capital
formation, employment in the home country, productivity, and economic growth in the
country. With respect to the mentioned importance, Foreign Direct Investment gets a great

6
deal of attention in empirical literature. However, in this study we will focus only on the
impact of FDI on growth in Afghanistan.

Existing empirical literature on FDI-growth nexus is somewhat enormous. This study

makes an attempt to review a few of such empirical studies.

Balasubramanyam et al (1996) by using cross-section data from developing countries and

applying OLS regressions found that FDI has a positive effect on economic growth of the
countries. Similarly, Bengoa and Sanchez-Robes (2003) find that FDI has a significant
positive impact on economic growth of developing countries but the magnitude of the
impact depends on the conditions of the host country. In a study conducted by Hussain and
Haque (2016) it has been revealed that there is a relationship between FDI, trade, and
growth rate of per capita GDP of Bangladesh. Furthermore, trade and foreign investment
variables have a significant impact on the growth rate of GDP per capita.

Supporting the previous results, Younus et al. (2014) have conducted a study on impact of
foreign direct investment on economic growth in Pakistan for the period 2000-2010 by
using two-stage least squares method of simultaneous equations estimation. The results
show a positive relationship between economic growth and FDI in Pakistan.

Fadhil and Almsafir (2015) in a study of the role of FDI inflows in Malaysia economic
growth have identified that FDI inflows together with the human capital development
contribute strongly to the Malaysian economic growth. The study by Nistor (2014) found a
correlation between FDI and economic growth. Moreover, FDI inflows had a positive
impact on GDP of host economies, manifesting differently depending on the area and the
region of the foreign investment; its impact depends largely on the quality and quantity of
the inflow.

As like, FDI is an important vehicle for the transfer of technology, contributing relatively
more to growth than domestic investment; however, the higher productivity of FDI holds
only when the host country has a minimum threshold stock of human capital (Borensztein,
De Gregorio, & Lee, 1998).

Osabuohien, Soogun, and Urhie (2017) have found that both domestic investment and
foreign direct investment had significant effect on Nigeria’s economic performance;
however, the influence of the former was observed to be far greater than the latter with
marked difference both in terms of the level of significance and size.

7
There are long-run relationships among all the variables under consideration in the
econometric model. The estimated long-run equation also indicates a positive association
between the explanatory variables and real gross domestic product. In particular, net
foreign direct capital was found to have a stronger influence on economic growth compared
to openness and real foreign exchange rate. Correspondingly, a unidirectional relationship
running from real exchange rate to net foreign direct investments was found. In addition,
amongst the three explanatory variables used in the model, openness and net foreign direct
investment contributed more towards innovations in economic growth during the forecast
horizon compared to real exchange rate variable (Ogbokor, 2016).

The paper by Khaliq and Noy (2007) investigates the impact of foreign direct investment
(FDI) on economic growth using detailed sectoral data for FDI inflows to Indonesia over
the period 1997-2006. In the aggregate level, FDI is observed to have a positive effect on
economic growth. However, when accounting for the different average growth performance
across sectors, the beneficial impact of FDI is no longer apparent. When examining
different impacts across sectors, estimation results show that the composition of FDI
matters for its effect on economic growth with very few sectors showing positive impact of
FDI and one sector even showing a robust negative impact of FDI inflows

Many authors have investigated the impact of FDI on economic growth in both developed
and developing countries and it can be concluded that it has both positive and negative
impact on different countries. The negative impact of FDI on economic growth of a number
of countries mostly depends on their weak economic, political and security conditions
including weak human resources or unavailability of skilled labor, weak institutions or tax
policy regulations, less developed technology or old machinery and etc. while on other hand
the positive impact of FDI is due to strong economic structure of the country for example,
sufficient infrastructure, skilled labor force, new technology and so on. These impacts are
not only limited to economic growth of the country but also other macroeconomic variables.
However, in this paper we limit ourselves with the impact of FDI on economic growth in
Afghanistan.

3. Theoretical Framework:
To begin with, it is important to define Economic Growth, Investment and distinguish
between their types.

8
Economic growth is the overall increase in the production of the country and it is measured
by the increase in total output or real GDP of the country. Economic growth is an
important indicator of a country’s health condition, as higher growth indicates higher
income, higher level of employment, higher tax income for the government, and higher
standard of living.

Investment: utilization of tangible and intangible capital in the form of cash, credit, material
goods, services or other types (i.e. patent, intellectual property, trademark and copyright) in
an enterprise approved by the High Commission on Investment.1

“Foreign Direct Investment” refers to direct investment equity flows in an economy. It is

the sum of equity capital, reinvestment of earnings, and other capital. Direct investment is a
category of cross-border investment associated with a resident in one economy having
control or a significant degree of influence on the management of an enterprise that is
resident in another economy (IMF, BoP).2

Foreign direct investment in Afghanistan and other countries reflects the foreign ownership
of production facilities. To be classified as foreign direct investment, the share of the foreign
ownership has to be equal to at least 10 percent of the value of the company. The
investment could be in manufacturing, services, agriculture, or other sectors. It could have
originated as green field investment (building something new), as acquisition (buying an
existing company) or joint venture (partnership).

Economists generally agree that economic growth is influenced by natural resources,

technological improvement, human capital and physical capital. These factors affect the rate
of economic growth and the excess amount of these factors will boost the country’s
economy by increasing its production capacity. Meanwhile, physical capital in terms of
whether domestic investment or foreign investment has attracted the attention of many
countries in order to achieve the target level of economic growth for their countries. There
are many theories on economic growth and capital investment and different economists
have described the relation between them differently. For example, Harrod (1939) - Domar
(1946) described that investment and savings are the key determinants of growth. Since
raising savings are difficult in developing countries, it is advised to borrow savings via
loans, foreign direct investment, and portfolio investment to achieve desired growth rates

1
Law on Domestic and Foreign Private Investment in Afghanistan
2
International Monetary Fund, Balance of Payments database, supplemented by data from the United Nations
Conference on Trade and Development and official national sources.

9
for different countries. Many developing countries have adopted FDI attracting policies and
tax incentives in order to reach to targeted levels of growth.

By introducing neoclassical model of growth (Solow), a new rationale for the flow of funds
from rich to developing countries was found, as diminishing returns on capital is assumed,
the return on investment in developing countries should be higher than developed countries
resulting in attracting funds from rich countries. Solow (1956) explained that sustained rise
in capital investment increases the growth rate only temporarily; because, the marginal
product of capital declines over time. He suggested that the capital, labor and output have to
grow at same rate in order to reach the steady-state growth path.

The endogenous growth theory by Romer (1990) states, that an increase in people working
in the knowledge sector will increase the domestic productivity and economic growth.

4. Data and Methodology:

The research reviews both theoretical and empirical literature discussing the role of foreign
direct investment and economic growth. Theoretical literature provides a clearer detail of
the analysis and the empirical to provide better understanding of relationship of foreign
direct investment and economic growth in Afghanistan.

In this study we have used secondary data to assess the impact of FDI on economic growth
in Afghanistan. There are some limitations that prevent us to include certain variables of
interest in the study especially time period of the data and dis-contiguousness or the lack of
uniformity of the observations, small number of observations so, we were not able to apply
some of the time series analysis techniques to the data. Time period of the data for GDP in
Afghanistan ranges from 2002 to 2019, Net FDI (2008 – 2019), CPI (2005 – 2019), and Net
Exports (2008 – 2019) obtained from Da Afghanistan Bank (DAB) and National Statistics
and Information Authority (NSIA). Therefore, we have estimated correlation among the
variables under consideration.

Model Specification
In order to know how FDI impacts economic growth in Afghanistan we estimated
correlation between the variables and ran causality test.

10
 5. Data Analysis and Interpretation
The descriptive methods are used to provide better understanding of relationship of foreign
direct investments and economic growth in Afghanistan. For the purpose above the
statistical software EViews is used for analysis of the data and extraction of the results. This
analysis clarifies the relationship between foreign direct investment and its impact on
Afghan economy.

To manage stationarity, the non-stationary data has been transformed to stationary after
taking first difference of the data. The observation period is, due to data availability, from
2008 until 2019. (See Appendix)

Descriptive Statistics
Table 1 indicates the descriptive statistics of studies variables throughout 2008-2018. The
minimum value of GDP is USD 10641.3 million in 2008 while the maximum value of GDP
is calculated as USD 21217.9 million in 2013. Moreover, the mean of GDP and standard
deviation are USD 18506.8 million and USD 3661.8 million, respectively. On the other
hand, the mean of Net FDI is 77.3 million, the standard deviation is USD 58.9 million, the
minimum value is USD 12.9 million and the maximum value is USD 197.5 million.

Table 5.1.

Variable Mean Std. Dev. Min Max

GDP 18506.8 3661.8 10641.3 21217.9
Net FDI 77.3 58.9 12.9 197.5
CPI 135.5 30.2 105.7 183.4
Net Exports -5911.8 1888.6 -9000 -2475.3

The two control variables are inflation rate and net exports with the mean values which are
135.5 and -5911.8, respectively.

Correlation Matrix
The analysis of the study is carried out from the correlation test to describe the statistical
relationship between GDP, FDI, CPI, and Net Exports. Correlation is the association of the
variables under consideration. It illustrates the strength of association between the variables
under consideration. From the correlation results it can be figured out that one variable
might move in one direction and the other variable in opposite direction or both the

11
variables might have the same direction. Correlation results are within the range of -1 and
+1. -1 indicates a perfect negative correlation while +1 indicates perfect positive correlation.

Table 5.2.

Variable GDP Net FDI CPI Net Exports

GDP 1.0000
Net FDI -0.3052 1.0000
CPI -0.7870 0.0888 1.0000
Net Exports -0.9178 0.2536 0.6923 1.0000

The correlation matrix above shows that Net FDI is negatively related to GDP the reason
behind that is the data for the period under consideration is unreliable and limited
observations.

Figure 5.1.

25000.0 250.0

20000.0 200.0
Millions USD

15000.0 150.0

NFDI
10000.0 100.0
GDP

5000.0 50.0

0.0 0.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Years

The figure above depicts the graphical representation of the relationship of GDP and Net
FDI from 2008 to 2017. From the figure above we can conclude that Net Foreign Direct
Investment has not contributed to the Gross Domestic Product of Afghanistan from the
years 2008 to 2017. The reason behind no contribution of foreign direct investment to the
gross domestic product is that Afghanistan has a very volatile economy and there exists
many other dominant factors affecting the GDP of the country including political

12
uncertainty, volatile economy, worse security situation, withdrawal of foreign troops,
continued war and violence and etc.

Since 2001, Afghanistan has witnessed a huge increase in the inflow of foreign direct
investment in the country, however, security conditions and political instability deterred the
effective use of FDI in the country and these two factors remained major challenges
throughout the period.

Figure 5.2.

NFDI as percentage of GDP

1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Foreign investments are not a huge part of Afghanistan’s gross domestic product and it has
a negligible impact on the state of the country’s economy. The figure above shows the trend
of FDI as percentage of GDP between 2008 and 2018. Net FDI as percentage of GDP has
witnessed a sharp decline from 2008 onwards due to a large number of withdrawal of
foreign troops and worsening security conditions in the country.
Since 2001, Afghanistan has received political and economic support of international
community it terms of dispatching military forces and infusion of billions of dollars’ aid
which paved the way for in the inflow of foreign direct investment in the country reaching
its highest in 2008/09 to 197.5 million USD and its minimum in 2017 to 12.9 million USD.
The figure above depicts that FDI flows have witnessed great volatility in the period under
consideration specially, in 2017 due to insecurity and political instability in the country. The
withdrawal of foreign troops from 2010 onwards also greatly affected the inflow of FDI
which resulted in huge decline over the years.

13
Figure 5.3.

2000 FDI inflows to economies and world, 2008-2017

(USD Billion)
1500

1000

500

0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

World Developed economies Developing economies Transition economies

Source: UNCTAD, FDI/MNE database (www.unctad.org/fdistatistics).

Foreign direct investment (FDI) flows to the world on average remained around $1,500
billion from the year 2008 to 2015. It increased to almost $2,000 billion in 2015 with
gradual decline over the next couple of years. This is due to weaker macroeconomic
performance and policy uncertainty for investors, including trade tensions.
With the increase in global FDI in 2015, FDI flows to the developed economies also
increased to over $1,000billion. However, it declined significantly in 2017 reaching to
around $700billion. Flows to the developing economies remained almost unchanged at an
estimated $650billion and flows to transition economies experienced a stable state of an
average of $60billion over the period 2008-2017. These trends are reflected in figure 5.3.
(above), indicating that during the years 2008-2017, 53.3% of FDI went to developed
countries, while 46.7% of FDI went to developing and transition economies.

14
Figure 5.4.

FDI Inflow to Developing Countries and Afghanistan

800.00

700.00

600.00

500.00

400.00

300.00

200.00

100.00

0.00
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Developing economies Afghanistan

Afghanistan is still not able to bounce back in terms of foreign direct investment inflows
compared to other developing countries as seen in the graph above. Lack of infrastructure,
worse security condition, political instability, bureaucracy and corruption at all levels in the
government are the biggest obstacles for the attraction of FDI to the country. Some of the
major obstacles that Afghanistan must deal with are as follows:

Factors affecting Foreign Direct Investment:

There are different factors to be considered before investing in countries, which are going to
be important for determining whether investing in these countries is beneficial or not.
These factors include wage rates, labor skills, tax rates, infrastructure and transport,
growth potential of the economy or the current economic condition of the country, political
stability, exchange rate, openness of the country, and etc.
Factors affecting foreign direct investment flows are many and vary from country to
country because it depends on social-economic and political dynamics of the countries.
Afghanistan a country affected by decades of war has adopted market economic system after
the end of the Taliban era. Post-Taliban era has been the period of reconstruction of the
country and development, yet, the country has not reaped the benefits from the huge
inflows of aid for reconstruction and development. Security and political instability have
remained the major challenges over the years hindering the reconstruction phase which in
result decreased the inflow of FDI to the country. Since 2001, Afghanistan has witnessed a
volatile FDI trend which is evident from the FDI trend line in the figure 1.2.

15
Afghanistan has worked on many investment support strategies in order to attract more
FDI to the country including low tax on FDI, land ownership for longer period of time,
easy licensing, providing electricity at lower costs and etc. but despite the availability of
potentials for the investment, the amount of foreign direct investment to the country is not
promising.
Afghanistan has joined certain world organizations including World Trade Organization
(WTO) and has signed multiple trade and investment agreements with the US, Europe, and
Asia, which could bring a number of opportunities for investment in the country. If the
country supports Foreign investments inflow or work for the improvement of investment
support strategies, this will result in increase in employment in the country as international
firms investing in Afghanistan will induce the local firms to increase their production and
become suppliers to the international firms. With the increase in the production the local
firms hire more people and results in higher employment in the country. By encouraging
investment opportunities in the country the international firms need to buy land or other
assets and for that they need national currency and they exchange foreign currencies to
local currency which will result in increase in foreign exchange reserves. FDI is also the
source of transfer of new technology and better managerial skills to the home country as
international firms use new technology and train local personnel. Sometimes, the employees
trained in international firms start their own businesses or try to join local firms and in that
way the knowledge and skills are transferred from international to local firms. Foreign
Direct Investment also paves the path to international markets as the international firms
already have exports to foreign countries so the host country will also benefit from the
establishment of new markets.
Afghanistan ranks among the most corrupt countries in the world and corruption includes
bribery which takes place for different reasons and mostly it happens in order to get better
services or faster services and influence actions such as police and judicial activities, misuse
of power, nepotism, and use of position for dishonest gain. Afghans consider corruption as a
major challenge that the country is currently facing and ranks it ahead of the poverty.
Corruption also has a very severe effect on many other factors including the current level of
investment, future investment opportunities, the quality of infrastructure, education and
healthcare system of the country. The final results of the projects implemented by foreign
investors or the products produced by foreign firms are likely to be limited or can be of low
quality if due to corruption not most qualified firms are awarded contracts to invest in the
country. Similarly, corruption in education system, health care system or in any other
government sector will ultimately effect the investors’ decision making whether to invest in

16
the country or not. Bureaucracy even without corruption also effects the decision of the
would-be investor as the excessive amount of time taken in order to get the work done or
issue the permit license or any other documentation process can result in not investing in
that particular sector of the country.
For the reasons above reducing corruption and less bureaucracy plays pivotal role in
attracting foreign investment and the government had to take initiatives for increasing the
inflow of foreign investment in order to promote growth and development in the country.

Table.5.3: Foreign Direct Investment (inward) from 2008 to 2019 (By Sector) In Million USD
Year Construction Services Industry Agriculture Mining
2008 23.12 13.39 9.39 0.13 -
2009 157.73 31.53 7.26 0.99 -
2010 25.57 19.87 7.32 1.44 -
2011 20.87 23.27 13.48 - -
2012 22.78 14.36 3.72 - -
2013 22.38 15.88 9.50 0.05 0.50
2014 9.59 19.78 13.60 - -
2015 8.22 147.85 9.05 4.03 -
2016 8.12 67.18 8.49 - 9.80
2017 9.69 41.37 2.11 0.12 0.10
2018 21.97 94.97 0.25 0.02 0.66
2019 3.90 37.91 0.25 0.01 0.07
Total 333.95 527.36 84.42 6.79 11.13
Source: BOP, DAB

According to Balance of Payment, Monetary Policy Department data from 2008 to 2019,
the total FDI inflows are distributed among services sector (54.73%), construction (34.65%),
industry (8.76%), mining (1.15%), and agriculture (0.70%). The services sector in
Afghanistan received the highest share in FDIs amounting to over 527 million USD from
2008 to 2019. This sector included banking, telecommunication, and aviation. The
construction sector came second amounting to almost 334 million USD from 2008 to 2019.
It must be acknowledged that these figures do not reflect the exact trends of FDI inflows to
Afghanistan as significant portion of FDI has been channeled through contractors and other
firms owned by foreigners.

17
Causality results
The results depict that there is no causality among the variables of interest. The
unavailability of causality is due to that Afghanistan has a very volatile economy and there
exists many other dominant factors affecting the GDP of the country including political
uncertainty, volatile economy, worse security situation, withdrawal of foreign troops,
continued war and violence and etc. It is worth mentioning that Foreign Direct Investment
plays a pivotal role in the growth of the country but as Afghanistan has faced significant
challenges including security transition, economic, and political concerns post 2014; the
country has not reaped the benefits of FDI inflows completely. The government of
Afghanistan encourages FDI in various sectors but from 2005-2013 FDI decreased due to
lack of rule of law and difficulty in government procedure for investing in the country.

Table 5.3.
Pairwise Granger Causality Tests
Sample: 2008 2018
Lags: 2
Null Hypothesis: Obs F-Statistic Prob.
DCPI does not Granger Cause DGDP1 7 0.32169 0.7566
DGDP1 does not Granger Cause DCPI 2.45367 0.2895
DNX does not Granger Cause DGDP1 7 0.63698 0.6109
DGDP1 does not Granger Cause DNX 0.53357 0.6521
DNFDI does not Granger Cause DGDP1 7 2.30754 0.3023
DGDP1 does not Granger Cause DNFDI 0.70233 0.5874
GDP1 does not Granger Cause DGDP1 7 NA NA
DGDP1 does not Granger Cause GDP1 NA NA
DNX does not Granger Cause DCPI 8 0.74313 0.5468
DCPI does not Granger Cause DNX 3.85184 0.1484
DNFDI does not Granger Cause DCPI 8 2.39066 0.2394
DCPI does not Granger Cause DNFDI 0.02276 0.9777
GDP1 does not Granger Cause DCPI 8 1.70144 0.3207
DCPI does not Granger Cause GDP1 0.72307 0.5543
DNFDI does not Granger Cause DNX 8 0.63860 0.5874
DNX does not Granger Cause DNFDI 0.38900 0.7076
GDP1 does not Granger Cause DNX 8 2.09941 0.2690
DNX does not Granger Cause GDP1 0.67611 0.5723
GDP1 does not Granger Cause DNFDI 8 0.64637 0.5842
DNFDI does not Granger Cause GDP1 2.33614 0.2445

18
 6. Conclusion and Policy Recommendations
This paper intends to study the relationship between foreign direct investment (FDI) and
economic growth in Afghanistan for the period 2008 to 2019. Having applied the
stationarity, it has been concluded that all the variables are non-stationary hence first
difference is taken to make the data stationary. The causality tests result show that there is
no causality among the variables. No causality among the variables could be the result of
unstable and volatile economic conditions of the country. Afghanistan’s economy is
dependent on agriculture which contributes around 30 percent to the GDP of the country
and the sector is not largely affected by the FDI.
From the results of causality tests and the rest of the analysis, we come to the conclusion
that it is needed for Afghanistan to attract the foreign direct investment to further economic
growth in the country. Afghanistan has experienced a very bad economic situation with the
lowest GDP of 1 billion USD before 2002 but has been increased with the establishment of
new government and the infusion of billions of USD aid and foreign direct investment
which supported the economy of the country. The amount of foreign direct investment has
been increased since then and reached its maximum in 2009/2010 to 197.5 million USD but
with it decreased with the gradual withdrawal of foreign troops and worsening economic
and security condition of the country.
Based on the study, we can conclude that Afghanistan must focus on improvement of
security situation in the country, rule of law, and human capacity building. As, these
improvements will pave the path for the higher economic growth. The infrastructure of the
country has been destroyed through years of war and unstable political situation which is
very unsupportive in terms of attracting FDI to the country as this increases the cost of
shipping and delays the transportation.
To attract the inflow of FDI to Afghanistan, new FDI law has to be drafted including
industry-specific investment laws, policies, tax regimes and etc. which in result will greatly
improve the investment climate in the country. Afghanistan in order to attract higher FDI
must work for the improvement of security situation which will reduce instability for the
investors, specifically international entrepreneurs. In Afghanistan, a very low percentage of
the population have access to finance which is not a favorable ratio compared with other
countries. The lack of access to finance for private businesses is one of the biggest
challenges for the Afghan economy. Private sector often faces difficulties when trying to
access finance. Only about 2 percent of all Afghan firms take loans to finance their
investments. Consequently, they often remain below their potential as they cannot expand,

19
innovate or hire additional staff. This results in low revenue generation and many potential
jobs being lost – major obstacles for the country’s economic development.
Finally, the existence of informal economy which comprises a large share in the country’s
GDP creates market distortions in Afghanistan and undermines clean government.

20
 7. References
Baiashvili, T., & Gattini, L. (2020). Impact of FDI on economic growth: The role of country
income levels and institutional strength (No. 2020/02). EIB Working Papers.

Balasubramanyam, V., Salisu, M., & Sapsford, D. (1996). Foreign Direct Investment and
Growth in EP and is Countries. The Economic Journal, 106(434), 92-105.
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Bengoa, M., & Sanchez-Robles, B. (2003). Foreign direct investment, economic freedom and
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National Financial Inclusion Strategy (Afghanistan) 2020-2024

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 8. Appendix
Null Hypothesis: GDP has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, max lag=1)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -3.829783 0.0199

Test critical values: 1% level -4.297073
5% level -3.212696
10% level -2.747676

*MacKinnon (1996) one-sided p-values.

Warning: Probabilities and critical values calculated for 20
observations
and may not be accurate for a sample size of 10

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(GDP)
Method: Least Squares
Date: 08/11/20 Time: 09:52
Sample (adjusted): 2009 2018
Included observations: 10 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

GDP(-1) -0.330028 0.086174 -3.829783 0.0050

C 7024.663 1608.322 4.367697 0.0024

R-squared 0.647068 Mean dependent var 981.1031

Adjusted R-squared 0.602951 S.D. dependent var 1558.841
S.E. of regression 982.2539 Akaike info criterion 16.79443
Sum squared resid 7718582. Schwarz criterion 16.85495
Log likelihood -81.97217 Hannan-Quinn criter. 16.72805
F-statistic 14.66724 Durbin-Watson stat 1.570023
Prob(F-statistic) 0.005019

Null Hypothesis: CPI has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, max lag=1)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -1.756947 0.3773

Test critical values: 1% level -4.297073
5% level -3.212696
10% level -2.747676

*MacKinnon (1996) one-sided p-values.

23
Warning: Probabilities and critical values calculated for 20
observations
and may not be accurate for a sample size of 10

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(CPI)
Method: Least Squares
Date: 08/11/20 Time: 09:51
Sample (adjusted): 2009 2018
Included observations: 10 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

CPI(-1) -0.444135 0.252788 -1.756947 0.1170

C 54.42661 35.62265 1.527865 0.1651

R-squared 0.278425 Mean dependent var -6.805000

Adjusted R-squared 0.188228 S.D. dependent var 25.88016
S.E. of regression 23.31760 Akaike info criterion 9.313151
Sum squared resid 4349.684 Schwarz criterion 9.373668
Log likelihood -44.56575 Hannan-Quinn criter. 9.246764
F-statistic 3.086863 Durbin-Watson stat 2.415621
Prob(F-statistic) 0.116989

Null Hypothesis: NFDI has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, max lag=1)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -3.568420 0.0294

Test critical values: 1% level -4.297073
5% level -3.212696
10% level -2.747676

*MacKinnon (1996) one-sided p-values.

Warning: Probabilities and critical values calculated for 20
observations
and may not be accurate for a sample size of 10

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(NFDI)
Method: Least Squares
Date: 08/11/20 Time: 09:52
Sample (adjusted): 2009 2018
Included observations: 10 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

24
NFDI(-1) -1.235711 0.346291 -3.568420 0.0073
C 97.80208 32.33495 3.024655 0.0164

R-squared 0.614153 Mean dependent var 6.908698

Adjusted R-squared 0.565922 S.D. dependent var 95.60330
S.E. of regression 62.98782 Akaike info criterion 11.30062
Sum squared resid 31739.72 Schwarz criterion 11.36113
Log likelihood -54.50308 Hannan-Quinn criter. 11.23423
F-statistic 12.73362 Durbin-Watson stat 1.477036
Prob(F-statistic) 0.007310

Null Hypothesis: NX has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, max lag=1)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -2.146097 0.2332

Test critical values: 1% level -4.297073
5% level -3.212696
10% level -2.747676

*MacKinnon (1996) one-sided p-values.

Warning: Probabilities and critical values calculated for 20
observations
and may not be accurate for a sample size of 10

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(NX)
Method: Least Squares
Date: 08/11/20 Time: 09:53
Sample (adjusted): 2009 2018
Included observations: 10 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

NX(-1) -0.422056 0.196662 -2.146097 0.0642

C -2874.556 1208.232 -2.379143 0.0446

R-squared 0.365368 Mean dependent var -405.6079

Adjusted R-squared 0.286039 S.D. dependent var 1381.790
S.E. of regression 1167.560 Akaike info criterion 17.14008
Sum squared resid 10905570 Schwarz criterion 17.20059
Log likelihood -83.70038 Hannan-Quinn criter. 17.07369
F-statistic 4.605731 Durbin-Watson stat 2.643866
Prob(F-statistic) 0.064164

25