ANALYSIS OF FDI AND ECONOMIC GROWTH IN NEPAL

A Proposal
Submitted to the Department of Economics, Patan Multiple Campus,
Faculty of Humanities and Social Sciences, Tribhuvan University,
Nepal, in Partial Fulfillment of the Requirements of the Degree of

MASTER OF ARTS
in
ECONOMICS

By Prashant Pokhrel
Roll No: 37/076
Regd. No. 7-2-518-142-2014
Department of Economics,
Patan Multiple Campus,
Tribhuvan University
Lalitpur, Nepal
Contact Tel: 9840576359
E-mail: prashantpokhrel57@[Link]

Jan, 2025
TABLE OF CONTENT

S
CHAPTER ONE..................................................................................................................4

INTRODUCTION...............................................................................................................4

1.1 Introduction................................................................................................................4

1.2 Background of the Study...........................................................................................4

1.3 Statement of the Problem...........................................................................................5

1.4 Research Question.....................................................................................................7

1.5 Objective of the Study...............................................................................................7

1.6 Significance of the Study...........................................................................................7

1.7 Scope and Limitation of the Study............................................................................8

1.8 Outline of the Study...................................................................................................9

CHAPTER TWO...............................................................................................................11

REVIEW OF LITERATURE............................................................................................11

2.1 Literature Review....................................................................................................11

2.1.1 International Context........................................................................................11

2.1.2 Nepalese Context..............................................................................................22

2.2 Research Gap...........................................................................................................35

CHAPTER THREE...........................................................................................................37

RESEARCH METHODOLOGY......................................................................................37

3.1 Introduction..............................................................................................................37

3.2 Conceptual Framework............................................................................................37

3.3 Research Design......................................................................................................38

3.4 Nature and Source of Data.......................................................................................38

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 3.5 Sample Size.............................................................................................................38

3.6 Tools of Analysis.....................................................................................................39

3.7 Model Specification.................................................................................................40

3.8 Operational Definition of Variable..........................................................................41

3.9 Methodological Matrix............................................................................................42

REFERENCES..................................................................................................................44

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 CHAPTER ONE

INTRODUCTION

1.1 Introduction

This chapter provides a summary of the research, explaining its background, the
problem it addresses, the main question it seeks to answer, its goals, why it's important,
and what limits it. The study focuses on exploring a certain topic to better understand a
specific problem.

1.2 Background of the Study

Foreign Direct Investment (FDI) has become a cornerstone of economic

development strategies across the globe, offering significant opportunities for growth and
industrialization, particularly in developing economies. FDI involves investments made
by foreign entities directly into the productive assets of a host country, rather than
through financial markets or portfolio investments. These investments are essential for
providing capital, technology, and managerial expertise that can enhance the economic
capabilities of host countries, making FDI a vital component in global economic progress
(Subedi, 2013).

Globally, FDI has played a critical role in transforming economies by driving

industrial growth, creating employment opportunities, and facilitating access to advanced
technologies. The flow of FDI into various regions has been influenced by factors such as
economic policies, market size, and the availability of resources. Countries with
favorable investment climates and robust economic policies have been successful in
attracting substantial FDI, which in turn has spurred economic development and
increased global competitiveness. However, the benefits of FDI are contingent upon the
host country's ability to create an environment conducive to foreign investments,
including transparent policies and stable governance (OECD, 2020).

In South Asia, FDI has been instrumental in driving economic growth and

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development. Countries like India and Bangladesh have effectively utilized FDI to
enhance their infrastructure, increase industrial output, and integrate into global markets.
The region has witnessed significant FDI inflows due to its large and growing consumer
base, competitive labor costs, and ongoing economic reforms. However, the distribution
and impact of FDI within South Asia have been uneven, with some countries benefiting
more than others. The success of FDI in contributing to economic development in South
Asia largely depends on each country's policy framework, political stability, and ability
to address challenges such as infrastructure deficits and regulatory hurdles (UNCTAD,
2016).

In Nepal, a developing country facing numerous economic challenges, FDI is

viewed as a crucial mechanism for injecting necessary capital, stimulating
industrialization, and driving economic growth. Nepal's economy is characterized by low
productivity, inadequate infrastructure, and socio-political instability, which have
hindered domestic capital formation and economic progress. FDI offers a pathway to
overcome these obstacles by introducing advanced technology, improving human capital
through training, and providing access to international markets. Despite its potential,
attracting and sustaining FDI in Nepal has been challenging due to factors such as
political instability, poor infrastructure, and economic disruptions caused by events like
the Gorkha earthquake in 2015 (Dahal, 2007; Koirala, 2006).

This study aims to analyze the relationship between FDI and economic growth in
Nepal, focusing on how foreign investments impact various aspects of economic
development, such as capital accumulation, technological advancement, and productivity
improvements. The research will also explore the challenges and opportunities associated
with FDI in Nepal and assess the effectiveness of current policies in creating a favorable
investment climate. By providing a comprehensive analysis, the study seeks to offer
recommendations for enhancing the role of FDI in driving Nepal's economic growth and
development, particularly in the context of its unique challenges and opportunities
(Gautam & Prasain, 2006).

1.3 Statement of the Problem

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 Foreign Direct Investment (FDI) is widely recognized as a critical driver of
economic growth, particularly in developing economies. FDI brings significant benefits
such as capital infusion, advanced technology, managerial expertise, and access to
international markets, all of which contribute to enhanced productivity and economic
performance. Empirical studies have shown that countries with substantial FDI inflows
often experience stronger economic development. However, the relationship between
FDI and economic growth is not straightforward. Its impact depends on factors such as
the host country’s economic policies, institutional quality, and capacity to absorb foreign
investments. In some cases, FDI may also result in negative outcomes, such as market
dominance by foreign firms or economic dependency, complicating the overall narrative
of its benefits.

In Nepal, FDI has gained attention as the country seeks to accelerate its economic
development through foreign capital investment. Over the years, the government has
implemented liberalized policies to attract foreign investors. Despite these efforts, Nepal
has struggled to achieve substantial FDI inflows, especially compared to other South
Asian countries. The FDI received is often concentrated in specific sectors like
hydropower and tourism, with minimal diversification into other high-potential sectors.
Political instability, bureaucratic inefficiencies, and inadequate infrastructure further
exacerbate the challenges, limiting the effectiveness of FDI in fostering sustained
economic growth.

Existing literature on FDI and economic growth in Nepal addresses various

dimensions, including government policies, sectoral distribution of FDI, and challenges
in attracting and utilizing foreign investment. While studies have explored FDI's sector-
specific impacts and broader macroeconomic implications, they fail to provide a holistic
understanding of how FDI interacts with domestic factors such as labor markets,
entrepreneurship, and regulatory frameworks to influence economic outcomes. This
knowledge gap is particularly pronounced in the context of Nepal’s unique political and
economic environment.

Given these challenges, the study seeks to address the following questions: How has FDI

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impacted economic growth in Nepal over the past decades? What are the key factors
influencing the relationship between FDI and economic growth in Nepal? How do
different economic sectors respond to FDI inflows, and what are the implications for
policymaking? What challenges and opportunities exist in optimizing FDI’s role in
promoting sustainable economic growth in Nepal? By answering these questions, this
research aims to provide a comprehensive analysis of FDI’s role in Nepal’s economic
development and offer actionable insights for policymakers and stakeholders.

1.4 Research Question

Based on problem statement and research gap of this study has raised following research
questions

 What are the trends of foreign direct investment (FDI) inflows in Nepal, and how do
these trends correlate with the country’s economic growth?
 What is the nature of relationship between foreign direct investment (FDI) and gross
domestic product (GDP) in Nepal?

1.5 Objective of the Study

Following research objectives has been made for this study based on the research
questions:

 To analyze the sector-wise trends of foreign direct investment (FDI) inflows in Nepal
and evaluate their specific impacts on economic growth across different sectors.
 To examine the relationship between foreign direct investment (FDI) and gross
domestic product (GDP) in Nepal, assessing both short-term and long-term effects

1.6 Significance of the Study

This study holds significant importance for advancing Nepal's economic

development and informing policy formulation. It aims to provide an in-depth
understanding of the relationship between Foreign Direct Investment (FDI) and economic
growth, offering actionable insights for policymakers. By analyzing the impact of FDI on

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Gross Domestic Product (GDP), the research will guide the development of targeted
policies to attract foreign investment and optimize its contribution to economic progress.
Such insights are crucial for identifying sectors with the highest growth potential and
prioritizing them for strategic interventions.

The study also plays a critical role in shaping Nepal’s development strategies by
examining sector-wise trends in FDI inflows. This analysis will help identify which
industries benefit most from foreign investments, facilitating sectoral prioritization and
resource allocation. Insights from this research can contribute to diversifying Nepal’s
economy, reducing its reliance on specific industries, and enhancing its resilience to
external economic shocks.

Furthermore, the findings will help improve Nepal's investment climate by

identifying gaps and deficiencies in the current policy framework. Recommendations
derived from this study can assist in creating a more investor-friendly environment,
fostering long-term economic growth. For the private sector, the insights will guide
businesses in identifying sectors with high growth potential for investment opportunities.

Beyond its practical implications, the study addresses critical challenges such as
low capital formation, unemployment, and poverty in Nepal. By optimizing the role of
FDI in addressing these challenges, the research can contribute to sustainable economic
growth and improved living standards.

Finally, this study adds to the academic discourse on FDI and economic growth in
developing economies, particularly in the context of Nepal. It fills existing gaps in the
literature and provides a comprehensive analysis that can serve as a foundation for future
research, making it a valuable contribution to both academic and policy-oriented
discussions. The findings are expected to play a pivotal role in guiding Nepal toward
sustainable economic development.

1.7 Scope and Limitation of the Study

The study focuses on analyzing the relationship between Foreign Direct

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Investment (FDI) and economic growth in Nepal. It examines FDI inflows across key
sectors of the economy, including energy, tourism, manufacturing, and services, to assess
their contributions to GDP growth, employment, and productivity. Additionally, the
research explores the policy environment, considering factors such as government
regulations, political stability, and institutional frameworks that influence the
effectiveness of FDI in promoting economic development.

However, the study has certain limitations. Data availability and reliability may
pose challenges, as official records on FDI in Nepal might be incomplete or outdated,
affecting the precision of the analysis. Moreover, the research primarily focuses on
economic aspects, potentially overlooking social, environmental, and cultural dimensions
of FDI. While the study aims to provide an overview of sectoral impacts, it does not
delve deeply into sector-specific issues, which could be explored further in specialized
studies. Additionally, external factors such as global economic conditions and
geopolitical developments, which lie beyond the study's scope, may influence FDI flows
and their impact on Nepal's economy.

Despite these limitations, the study seeks to offer valuable insights into
optimizing FDI's role in driving sustainable economic growth in Nepal, providing
evidence-based recommendations for policymakers and stakeholders.

1.8 Outline of the Study

This study will be organized into five chapters.

Chapter I will be an introduction part. This chapter will contain various aspects of the
study. It includes background of the study, focus of the study, objectives, statement of the
problem, limitations and organization of the study.

Chapter II deals with review of literature, it includes study of related books, research
works, journal and articles which are already published and conducted by different
experts and researchers in the related fields.

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Chapter III includes the research methodology process such as research design, nature
and source of data, population and sampling of the study, methods and tools of data
collection and analysis.

Chapter IV deals with data presentation and analysis it deals with the presentation and
analysis of relevant data and major findings from the study. Various financial and
statistical tools will be used for this purpose of data analysis.

Chapter V will include Summary and Conclusion. This chapter will present summary,
conclusion and recommendations.

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 CHAPTER TWO

REVIEW OF LITERATURE

2.1 Literature Review

This section provides a comprehensive review of existing literature related to the

research topic. This review encompasses sources such as research papers, books, reports,
and bulletins, focusing on both international and national contexts to offer a thorough
understanding of the study area.

2.1.1 International Context

The relationship between Foreign Direct Investment (FDI) and economic growth
has been a central focus of economic research, with a wealth of empirical studies
exploring this dynamic. Despite extensive research, findings remain mixed, reflecting the
complexity and variability of the FDI-growth nexus across different contexts. Some
studies report a positive impact of FDI on economic growth, arguing that FDI serves as a
catalyst for capital formation, technology transfer, and employment creation, thereby
enhancing productivity and economic development. However, other studies present more
nuanced or even contradictory results, suggesting that the impact of FDI can be neutral or
negative, depending on various factors such as the sector receiving the investment, the
host country’s regulatory environment, and the level of economic development. This
divergence in findings underscores the importance of context-specific analysis in
understanding the true nature of the relationship between FDI and economic growth.

The study conducted by Fazaalloh (2024) aims to investigate the relationship

between Foreign Direct Investment (FDI) and economic growth across various provinces
in Indonesia. The primary objective is to provide empirical evidence on how FDI
influences economic growth, particularly through mechanisms such as capital
accumulation and technology transfer. This research is significant as it addresses the
ongoing debate in the literature regarding the positive contributions of FDI to economic
growth, which have yielded mixed results in previous studies.

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 To achieve its objectives, the study employs a quantitative approach, utilizing
panel data analysis to assess the impact of FDI on economic growth. The dataset
encompasses multiple provinces over a specified period, allowing for a comprehensive
examination of regional differences in the effects of FDI. The author applies fixed effects
and random effects models to control for unobserved heterogeneity among provinces,
ensuring robust results. Additionally, various control variables, including government
expenditure, local investment, and inflation rates, are incorporated to isolate the effect of
FDI on economic growth. This methodological rigor enhances the reliability of the
findings and contributes to the understanding of the FDI-growth nexus.

The findings of the study indicate a positive relationship between FDI and
economic growth in Indonesia. Specifically, the results suggest that FDI contributes
significantly to the growth of Gross Domestic Product (GDP) across provinces. The
author highlights that the sectoral composition of FDI plays a crucial role, with certain
sectors demonstrating a stronger impact on economic growth than others. For instance,
FDI in sectors such as manufacturing and services is shown to have a more pronounced
effect compared to agriculture. Furthermore, the study emphasizes the importance of
institutional quality and infrastructure in maximizing the benefits of FDI, suggesting that
regions with better governance and facilities are more likely to attract FDI and,
consequently, experience higher growth rates.

In conclusion, Fazaalloh's (2024) research provides valuable insights into the

dynamics of FDI and economic growth in Indonesia. The study underscores the necessity
for policymakers to create an enabling environment that attracts FDI, particularly by
improving institutional frameworks and infrastructure. These findings contribute to the
broader literature on FDI and economic development, offering a nuanced understanding
of how regional factors influence the effectiveness of foreign investments. Overall, this
research serves as a critical resource for both scholars and policymakers interested in
harnessing the potential of FDI to drive economic growth in Indonesia.

The article "Does Economic Growth Attract FDI Inflows? A Dynamic Panel
Analysis" by Pascal L. Ghazalian (2024) provides a comprehensive examination of the
relationship between economic growth and foreign direct investment (FDI) inflows.

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Utilizing a dynamic empirical framework, the study analyzes a panel dataset that spans
from 2005 to 2019, encompassing both developing and developed economies. The
research employs the Generalized Method of Moments (GMM) System estimators to
assess the short-run and long-run effects of economic growth on FDI inflows. The
findings reveal significant positive effects of economic growth on FDI, indicating that
these effects remain statistically consistent over time and do not diminish at higher levels
of economic growth (Ghazalian, 2024).

Ghazalian's analysis highlights important variations in the impact of economic

growth on FDI across different geo-economic regions. Specifically, the results suggest
that FDI inflows are particularly responsive to economic growth in middle-income
countries, where adequate infrastructure and institutions are present. In contrast, the
effects are less pronounced in regions such as the Middle East and North Africa (MENA)
and Sub-Saharan Africa (SSA), where FDI is often driven by resource-seeking
motivations and hindered by inadequate infrastructure (Ghazalian, 2024). The study also
emphasizes the role of trade and foreign investment openness, suggesting that countries
with higher levels of openness are more likely to attract FDI in response to economic
growth (Ghazalian, 2024).

Overall, Ghazalian's research contributes valuable insights into the dynamics of

FDI attraction, underscoring the importance of developing growth-enhancing policies
tailored to the economic and geo-economic characteristics of host countries. The findings
advocate for a strategic approach that combines economic growth with increased
openness to international trade and foreign investment, thereby fostering a more
conducive environment for attracting FDI. This article serves as a significant addition to
the existing literature on FDI, providing empirical evidence that supports the notion that
economic growth is a critical factor in attracting foreign investment (Ghazalian, 2024).

Ahmed Mtiraoui, Hamdaoui, and Mhiri (2024) examine the interplay between
Islamic financial development, foreign direct investment (FDI), and economic growth
within the MENA region and East Asia and the Pacific from 1990 to 2018. Their study
employs simultaneous equations models to uncover both direct and indirect impacts of
Islamic financial development on economic growth, focusing particularly on the

13
mediating role of FDI. The authors reveal a direct positive relationship between Islamic
financial development and economic growth. Additionally, they demonstrate that Islamic
financial development has an indirect effect on economic growth through its influence on
FDI (Ahmed Mtiraoui et al., 2024). Their results emphasize the critical role of
governance quality in boosting economic growth, even when political stability is present.
Structural factors such as human capital, infrastructure, and trade openness are
highlighted as vital for enhancing the benefits of FDI.

The study suggests that microeconomic incentive policies, which are integral to
attractiveness strategies, should be deployed when an economy has reached a certain
level of structural development. These policies are most effective when part of broader
development strategies that address factors complementary to FDI. The authors argue that
while foreign investment is beneficial, it cannot replace a comprehensive long-term
development strategy that incorporates Islamic financial development for achieving
sustainable economic growth (Ahmed Mtiraoui et al., 2024).

Kumari, Shabbir, Saleem, Khan, Abbasi, and Lopez (2023) contribute to this
discourse by examining these relationships specifically within the Indian economy from
1985 to 2018. This study utilizes Johansen cointegration and vector autoregression
(VAR) models to explore both long-term and causal dynamics among FDI, trade
openness, and economic growth. According to Kumari et al. (2023), their analysis reveals
no long-term cointegration among FDI, trade openness, and economic growth. This
finding contrasts with some studies suggesting a stable long-term relationship between
these variables. The absence of long-term cointegration implies that while these variables
interact, their relationships do not converge to a stable long-term equilibrium. This is
significant because it challenges the notion that FDI, trade openness, and economic
growth are consistently linked over extended periods (Kumari et al., 2023).

The VAR Granger causality tests in the study uncover bi-directional causality
between FDI and economic growth, indicating that each variable influences the other.
This result supports the view that FDI and economic growth are mutually reinforcing, a
finding consistent with the broader literature which often highlights the positive feedback
loop between investment and growth (Kumari et al., 2023). However, the study finds no

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bi-directional causality between trade openness and economic growth, suggesting that
trade openness does not significantly drive economic growth in the same manner as FDI.
The implications of these findings are particularly relevant for policymakers. The study
suggests that India’s approach to foreign investment should consider the role of trade
openness, as the interaction between these factors can influence FDI flows. The impulse
analysis presented by Kumari et al. (2023) offers insights into potential future trends in
FDI, trade openness, and economic growth, guiding strategic decisions for the next
decade.

Overall, Kumari et al. (2023) offer valuable contributions to the understanding of

how FDI, trade openness, and economic growth interact in the Indian context. Their
findings highlight the complexity of these relationships and provide a nuanced
perspective that challenges some of the established views in the literature. This study
underscores the importance of considering specific national contexts when analyzing the
impact of FDI and trade openness on economic growth.

Luo, Guo, Ali, and Zhang (2022) investigate the dynamic impact of Foreign
Direct Investment (FDI) on economic growth and carbon emissions in China, India, and
Singapore, testing the Pollution Haven Hypothesis (PHH) and the Environmental
Kuznets Curve (EKC) hypothesis. The study uses data from 1980 to 2020 and applies
Westerlund's panel cointegration test to assess long-run equilibrium relationships among
the variables. The results indicate that both renewable and non-renewable energy
consumption, along with FDI and capital accumulation, significantly affect economic
growth. However, the labor force was found to be insignificant in this context, while
carbon emissions negatively impact economic growth.

The authors find that non-renewable energy consumption significantly increases

carbon emissions, whereas renewable energy consumption reduces them. This supports
the PHH by demonstrating that non-renewable energy exacerbates the environmental
impact of FDI. Additionally, the study validates the EKC hypothesis by showing an
inverted U-shaped relationship between economic growth and carbon emissions in the
studied countries. Luo et al. (2022) suggest that policymakers should focus on enhancing
renewable energy maturity and incorporating advanced, clean technologies into foreign

15
investments to mitigate environmental damage and foster sustainable economic growth.

The study by Asafo-Agyei and Kodongo (2022) investigates the impact of

Foreign Direct Investment (FDI) on economic growth in Sub-Saharan Africa, focusing on
the role of absorptive capacity and the necessary thresholds of FDI inflows for positive
economic outcomes. The researchers use a threshold regression model to explore the
nonlinear relationship between FDI inflows and economic growth. Their analysis reveals
that achieving a threshold level of FDI inflows, approximately US$ 44.67 per person
annually, is crucial for FDI to positively affect economic growth. Additionally, the study
highlights that for FDI to be beneficial, countries must also reach specific absorptive
capacity thresholds, such as a technology gap of at least 0.6904 between foreign and
domestic enterprises (Asafo-Agyei & Kodongo, 2022).

The study employs panel data from various Sub-Saharan African countries,
spanning several years, to assess the effects of FDI and absorptive capacity on economic
growth. By applying the threshold regression model, the researchers identify critical
levels of FDI inflows and absorptive capacity required for FDI to contribute positively to
economic development. The findings indicate that at FDI inflow levels below the
threshold, the associated costs of incentives, like tax concessions, can outweigh the
potential benefits, resulting in negative impacts (Asafo-Agyei & Kodongo, 2022).

In conclusion, the research underscores that while reaching the FDI threshold
level is necessary for economic growth, it is insufficient on its own. Effective utilization
of FDI requires achieving both the FDI inflow thresholds and adequate absorptive
capacity. The study provides valuable insights for policymakers, emphasizing the need
for reforms to enhance absorptive capacity in order to maximize the benefits of FDI
(Asafo-Agyei & Kodongo, 2022). However, the study’s focus on Sub-Saharan Africa
limits its generalizability to other regions with different economic contexts. The
identified thresholds and findings are specific to the region’s economic and institutional
conditions (Asafo-Agyei & Kodongo, 2022).

Wang, Xu, Qin, and Skare (2022) conducted a comprehensive bibliometric

analysis to explore the evolution of research on FDI and economic growth, covering
1,075 documents over nearly three decades. This analysis provides insights into the key

16
trends, thematic developments, and influential contributors in the field, offering a
valuable perspective for understanding the FDI-economic growth nexus. Using
Bibliometrix software, the study mapped out the leading researchers, conceptual
structures, and thematic evolution within the FDI-economic growth literature. C. Chen
was identified as one of the most influential contributors, having been active in this
research area for over two decades. The study also highlighted that the Journal of
International Economics is the most impactful journal in this domain, followed by other
significant publications like World Development and Journal of Development Studies
(Wang et al., 2022). These journals have played a crucial role in disseminating high-
impact research on FDI and its relationship with economic growth.

Research focus within the FDI-economic growth domain has shifted over time,
with initial studies concentrating on globalization and its economic impacts. More
recently, there has been an increasing emphasis on environmental concerns, particularly
CO2 emissions, as integral to the FDI-economic growth relationship. This shift reflects a
broader trend in economic research, where sustainability and environmental impact have
become central themes (Wang et al., 2022). The geographical distribution of FDI
research was also examined, noting that the USA has been the most recognized and cited
country in this field, while China has produced the most significant number of documents
and research collaborations. This global distribution underscores the importance of FDI
research across different economic contexts and highlights the collaborative nature of this
research area (Wang et al., 2022).

The analysis identified four distinct sub-periods in the thematic evolution of FDI-
economic growth research: 1992-2012, 2013-2016, 2017-2019, and 2020-2021. In the
initial period, research focused on globalization and economic growth, whereas later
periods saw a shift towards understanding the determinants of FDI, spill-over effects, and
environmental impacts. The emergence of new research themes, such as the role of FDI
in CO2 emissions and sustainable development, indicates the dynamic nature of this
research area and the increasing complexity of FDI's role in economic growth (Wang et
al., 2022). In conclusion, the bibliometric analysis by Wang et al. (2022) provides a
comprehensive overview of the evolution of research on FDI and economic growth. It

17
highlights the importance of understanding the changing focus of this research,
particularly the growing emphasis on sustainability. For countries like Nepal, where FDI
plays a critical role in economic development, these insights are crucial for shaping
policies that not only attract FDI but also ensure that it contributes to sustainable and
inclusive growth.

Cicea and Marinescu (2021) conducted a bibliometric analysis to explore the

scientific literature on the FDI-economic growth nexus, analyzing 2,281 documents from
the Scopus database. Their study utilized bibliometric tools such as VOSViewer and
Citespace to evaluate various dimensions of the literature, including the types of
information dissemination, thematic areas of publications, and the temporal and
geographical distribution of documents.

The analysis revealed a strong and evolving relationship between FDI and
economic growth. Initially, the literature primarily addressed broad economic impacts of
FDI, including its effects on GDP, employment, and technological progress. However,
over time, the research focus has shifted towards examining the environmental
implications of FDI, reflecting a growing global concern for sustainability (Cicea &
Marinescu, 2021). This shift highlights the dynamic nature of the FDI-economic growth
relationship, which is increasingly influenced by global trends such as environmental
protection and sustainable development. Through cluster analysis using VOSViewer, the
authors found a significant concentration of research on the impact of FDI across various
economic sectors. The strength of this connection suggests that FDI is a key driver of
economic performance in host countries. Additionally, by analyzing citation bursts and
keyword strengths, Cicea and Marinescu (2021) identified emerging trends in the
literature, including a notable shift from traditional economic aspects to environmental
considerations. This evolution in research focus underscores the necessity of
incorporating environmental sustainability into the analysis of FDI's impact on economic
growth.

In the context of Nepal, these findings emphasize the importance of understanding

both the economic and environmental implications of FDI. As Nepal continues to attract
FDI, policymakers must consider not only the direct economic benefits but also the

18
potential environmental impacts, ensuring that FDI contributes to sustainable and
inclusive growth. The work of Cicea and Marinescu (2021) provides a comprehensive
overview of the existing literature on FDI and economic growth, offering a valuable
foundation for further research, particularly in country-specific contexts like Nepal. Their
study suggests that future research should continue to explore the nuanced and evolving
relationship between FDI and economic growth, with a focus on sustainability and
environmental impact.

Osei and Kim (2020) investigate the relationship between financial development,
foreign direct investment (FDI), and economic growth. Their study addresses the
question of whether greater financial development enhances the positive impact of FDI
on economic growth. Using a dynamic panel threshold model with generalized method of
moments (GMM), they find that while FDI generally promotes economic growth, this
effect diminishes once financial development surpasses a certain threshold (Osei & Kim,
2020).

Their findings suggest a non-linear relationship between financial development

and economic growth, revealing that beyond a specific level of financial development—
95.6% of private sector credit to GDP—the marginal benefit of additional financial
development on the growth effect of FDI becomes negligible. This result challenges the
assumption that more financial development is always better for economic growth and
highlights the potential for diminishing returns (Osei & Kim, 2020). The authors argue
that financial development initially supports economic growth by facilitating the positive
impacts of FDI, such as technology transfer and managerial skills enhancement.
However, excessive financial development can lead to financial crises or bubbles, which
ultimately constrain growth. Their study underscores the importance of maintaining a
balanced level of financial development to optimize the benefits of FDI (Osei & Kim,
2020).

In conclusion, the paper emphasizes that while a well-developed financial sector

is crucial for leveraging FDI to boost economic growth, there is a threshold beyond
which further financial development does not necessarily yield additional growth
benefits. This insight is valuable for policymakers aiming to design effective strategies to

19
attract and benefit from FDI (Osei & Kim, 2020).

Chaudhury, Nanda, and Tyagi (2020) explore the impact of Foreign Direct
Investment (FDI) on economic growth in South Asia, focusing on how the sectoral
composition of FDI influences this relationship. They argue that while FDI is widely
recognized as a crucial driver of economic growth in developing countries, its effects can
vary significantly depending on the sector of investment. Their study highlights the
differential impacts of FDI across primary, secondary, and tertiary sectors, suggesting
that the sectoral distribution of FDI plays a critical role in shaping economic outcomes.
Using a holistic approach, the authors examine the nature and behavior of both overall
and sectoral FDI inflows in South Asian countries, integrating various factors such as
domestic investment, inflation, infrastructure, and external trade. Their findings indicate
that sectoral composition significantly affects economic growth, with different sectors
contributing in diverse ways. For instance, FDI directed toward the primary sector has
distinct implications compared to investments in the secondary or tertiary sectors
(Chaudhury, Nanda, & Tyagi, 2020).

The study concludes that understanding the sectoral distribution of FDI is

essential for crafting effective policies aimed at maximizing the benefits of foreign
investment. The research underscores the importance of context-specific analysis in
assessing FDI's impact on economic development, although its findings are most relevant
to South Asia and may not directly apply to other regions with different economic
contexts (Chaudhury, Nanda, & Tyagi, 2020).

Ciobanu (2020) explores the impact of FDI on Romania's economic growth,

focusing on the relationship between FDI, trade openness, labor force, and GDP growth
over the past few decades. This study contributes to the existing literature by examining
both the long-run and short-run dynamics of these relationships using advanced
econometric techniques.

The study employs the ARDL bound testing approach to investigate the long-run
relationships among FDI, trade openness, labor force, and economic growth. The results
indicate a significant cointegration among these variables, suggesting that FDI, trade
openness, and labor force are crucial determinants of Romania's economic growth in the

20
long term. This finding aligns with the broader literature, which consistently emphasizes
the positive effects of FDI on economic growth, particularly in countries that have
embraced trade liberalization and have a growing labor force (Ciobanu, 2020).

In addition to long-run analysis, the study also uses an error-correction based

Granger causality test to explore the direction of causality between the variables. The
results reveal that an increase in GDP, exports, imports, and labor force promotes FDI in
Romania over the long term. This bidirectional relationship between FDI and economic
growth is supported by the literature, which suggests that not only does FDI contribute to
economic growth, but economic growth, in turn, attracts more FDI by improving market
conditions and increasing investor confidence (Ciobanu, 2020).

Ciobanu's (2020) research on Romania is consistent with global findings that

highlight the importance of FDI in fostering economic development. The study
underscores the role of trade openness and labor force expansion as complementary
factors that enhance the positive impact of FDI on economic growth. This is particularly
relevant for countries like Romania, where economic policies that encourage trade and
investment can have a substantial impact on long-term development prospects.

Overall, this study adds to the growing body of literature that examines the
complex interplay between FDI, trade, labor, and economic growth. It reinforces the view
that FDI is a critical component of economic development, particularly when supported
by policies that promote openness and labor market growth. The findings from Romania's
experience provide valuable insights for other emerging markets seeking to harness the
benefits of FDI for sustainable economic growth.

The relationship between Foreign Direct Investment (FDI) and economic growth
is a well-researched area in economics, revealing a complex and varied landscape across
different contexts. Research findings on this relationship are mixed, with some studies
indicating a positive impact of FDI on economic growth due to factors such as capital
formation, technology transfer, and employment creation. However, other studies suggest
that FDI's impact can be neutral or even negative, depending on factors like the sector
receiving the investment, the host country’s regulatory environment, and its level of
economic development. This variability highlights the importance of context-specific

21
analysis. For instance, Fazaalloh (2024) explores the FDI-economic growth relationship
in Indonesia, utilizing panel data analysis across various provinces. The study finds a
generally positive effect of FDI on economic growth, particularly in sectors such as
manufacturing and services, while emphasizing the role of institutional quality and
infrastructure. In contrast, Ghazalian (2024) employs dynamic panel analysis to assess
how economic growth attracts FDI, revealing a significant positive effect in middle-
income countries but less pronounced in regions like the Middle East and North Africa.

Ahmed Mtiraoui et al. (2024) investigate the impact of Islamic financial

development on economic growth, showing that while it has a direct positive effect, its
impact is also mediated by FDI. They stress that for FDI to be beneficial, structural
factors such as human capital and infrastructure are essential. Conversely, Kumari et al.
(2023) find no long-term cointegration between FDI, trade openness, and economic
growth in India, although they observe a bi-directional causality between FDI and
economic growth, suggesting a mutually reinforcing relationship. Further, Luo et al.
(2022) analyze the impact of FDI on economic growth and carbon emissions in China,
India, and Singapore, confirming that non-renewable energy consumption exacerbates the
environmental impact of FDI, while renewable energy helps mitigate it. Asafo-Agyei and
Kodongo (2022) focus on Sub-Saharan Africa, revealing that achieving a threshold level
of FDI and absorptive capacity is crucial for positive economic outcomes. Bibliometric
analyses by Wang et al. (2022) and Cicea and Marinescu (2021) reveal a shifting focus in
FDI research from general economic impacts to include environmental considerations
and sustainability. Wang et al. (2022) document the evolution of FDI research over
decades, highlighting the growing importance of environmental impact, while Cicea and
Marinescu (2021) emphasize the shift towards understanding FDI’s environmental
effects.

Lastly, Osei and Kim (2020) examine the role of financial development in
enhancing the impact of FDI on economic growth, finding that while initial financial
development supports growth, excessive development beyond a certain threshold can
lead to diminishing returns. This finding underscores the need for balanced financial

22
development to maximize the benefits of FDI. Overall, these studies collectively
contribute to a nuanced understanding of the FDI-economic growth relationship,
emphasizing the need for context-specific policies and balanced approaches to harness
the benefits of FDI while mitigating potential drawbacks.

2.1.2 Nepalese Context

Dahal, Bhattarai, and Budhathoki (2024) investigate the relationship between

foreign trade, foreign direct investment (FDI), and economic growth in Nepal, using
secondary data spanning from 1989/90 to 2021/22. This study, published in Problems and
Perspectives in Management, employs descriptive and explanatory research designs,
alongside advanced econometric methods including the trace and max-eigen tests and the
fully modified least squares approach, to explore long-run co-integration and the impact
of these variables on Nepal’s economic growth (Dahal, Bhattarai, & Budhathoki, 2024).
The research findings indicate a complex interplay between foreign trade, FDI, and
economic growth. Specifically, the study reveals that exports and imports have a negative
and statistically significant impact on economic growth. A one-unit increase in exports
corresponds to a 0.748-unit decrease in GDP, suggesting that the export of raw materials
may be detrimental to Nepal's economic performance (Dahal et al., 2024). Conversely,
total trade volume and FDI are found to positively influence economic growth. The
analysis shows that a one-unit increase in FDI results in a 0.0036-unit increase in GDP
(Dahal et al., 2024).

The study highlights that 76.35% of the variation in economic growth can be
explained by changes in total foreign trade volume, exports, imports, and FDI. Despite
the negative impact of exports on growth, the overall contribution of foreign trade and
FDI to Nepal’s GDP is positive, suggesting that these factors have a multiplier effect on
economic development (Dahal et al., 2024). The authors recommend that policymakers
focus on increasing total foreign trade and FDI while promoting domestic industries to
reduce reliance on raw material exports. They emphasize the need for balanced
development across industrial, agricultural, and tertiary sectors to enhance economic
growth (Dahal et al., 2024). The study underscores the importance of creating a favorable
environment for international trade and foreign investment to sustain economic progress.

23
 Aryal, Oli, Shah, and Gopali (2024) explore the sector-specific impacts of Foreign
Direct Investment (FDI) on economic growth in Nepal using a comprehensive
econometric approach. Published in the Asian Journal of Empirical Research, this study
provides an in-depth analysis of how FDI influences different sectors such as
manufacturing, services, and agriculture, and aims to offer actionable insights for
policymakers and stakeholders (Aryal, Oli, Shah, & Gopali, 2024). The authors utilize a
robust methodology that includes unit root tests, Error Correction Models (ECM), and the
Autoregressive Distributed Lag (ARDL) model to analyze the long-term and short-term
dynamics between FDI and economic growth indicators. They apply the ARDL bound
test to investigate cointegration and Granger causality tests to determine the direction of
causality between FDI and GDP (Aryal et al., 2024).

The study’s findings reveal a positive linear relationship between Real GDP and
overall FDI, indicating that FDI significantly contributes to economic growth. Sectoral
analyses show that FDI in the agriculture sector has a direct positive impact on GDP,
potentially through enhanced productivity and exports. Conversely, FDI in the
manufacturing and service sectors does not show a direct causality to GDP but instead
has an indirect influence, suggesting these sectors may act as intermediaries (Aryal et al.,
2024). The study also highlights that the data's normal distribution and the robustness of
the models enhance the reliability of the results. The research underscores the importance
of considering sector-specific impacts when formulating strategies to attract and utilize
FDI. While the study provides valuable insights, it also points out that other factors, such
as infrastructure, education, and political stability, are crucial for sustained economic
development (Aryal et al., 2024). The paper calls for a holistic approach to FDI policy,
suggesting that improvements in the business environment and incentives could further
stimulate growth.

Gautam's (2024) article, "Correlation between Foreign Direct Investment and

Economic Growth in Nepal," investigates the relationship between Foreign Direct
Investment (FDI) and economic growth in Nepal from fiscal year 1994 to 2021. The
study provides a detailed analysis of FDI's impact on Real Gross Domestic Product
(RGDP), examining sector-wise FDI inflows and their effects on Nepal's economic

24
development. The research utilizes the Augmented Dickey-Fuller (ADF) test to
determine data stationarity, finding that all variables are integrated of order 1 (I(1)),
which necessitates first differencing for stationarity. This is crucial for ensuring the
accuracy of subsequent econometric analyses. The Engle-Granger co-integration test
further supports the long-term validity of the Ordinary Least Squares (OLS) model,
demonstrating a co-integrating relationship among the variables.

Gautam's (2024) findings reveal a significant long-term effect of FDI on RGDP,

with a one percent increase in FDI leading to a 0.12 percent increase in RGDP, assuming
other factors remain constant. This highlights the substantial role of FDI in promoting
economic growth. In contrast, the Error Correction Model (ECM) indicates a minimal
short-term impact of FDI on RGDP, with a coefficient of 0.007. However, the negative
and significant Error Correction Term (ECT) suggests that FDI and other variables are
moving towards a long-run equilibrium. The robustness of the model is further confirmed
by the CUSUM of squares and Cumulative Sum (CUSUM) tests, which indicate that the
model remains within the 5 percent significance threshold, ensuring the reliability of the
results.

In summary, Gautam's (2024) study underscores the critical role of FDI in Nepal's
economic development. While the short-term impact of FDI is limited, its long-term
benefits, including increased productivity and capital accumulation, are substantial. The
research emphasizes the need for a more investor-friendly environment to boost FDI
inflows and address challenges related to domestic capital accumulation, thereby
fostering sustained economic growth in Nepal.

Foreign Direct Investment (FDI) has been a critical element in the economic
growth of developing countries, including Nepal. According to Gharti (2023), FDI
inflows in Nepal have fluctuated over time, reflecting the shifts in the country’s policies
toward foreign investment and its broader economic framework. In Nepal’s case, foreign
investment trends have been influenced by historical changes in government policy, such
as the shift from import substitution in the mid-20th century to an emphasis on private
sector involvement in the 1990s. Several studies have established the importance of FDI

25
in stimulating economic growth. For instance, Gharti (2023) found that FDI positively
affects Real Gross Domestic Product (RGDP) in the long run. Specifically, a 1% increase
in FDI leads to a 0.12% increase in RGDP, while the short-term effects are not as
significant. This aligns with previous research by Ajayi (2006) and Chakrabarti (2001),
who argue that FDI inflows contribute to higher productivity, enhance resource
efficiency, and foster technology transfer, thus promoting economic growth.
Furthermore, FDI is seen as crucial for capital accumulation, both physical and human,
which is essential for long-term development (Balasubramanyam et al., 1996).

The study conducted by Gharti (2023) employs the Engle-Granger co-integration

method to assess the long-term relationship between FDI and RGDP. The findings
suggest that the variables are co-integrated, indicating that a long-term equilibrium
relationship exists between FDI and economic growth. This result is consistent with the
work of Borensztein et al. (1998), who concluded that FDI has a significant and positive
impact on GDP growth in developing economies, but only when complementary factors
like human capital and a conducive policy environment are present. Furthermore, the
study used the Error Correction Model (ECM) to analyze short-run dynamics and found
that FDI has an insignificant positive relationship with RGDP in the short run. The
negative coefficient of the Error Correction Term (ECT) indicates that the variables are
converging toward a long-run equilibrium. This supports the findings of Razafimahefa
(2011), who emphasizes that the effects of FDI are often delayed and more noticeable in
the long run.

FDI’s positive spillover effects, such as technological advancement, skill

development, and enhanced productivity, are essential for Nepal's economic
development. According to the study, FDI can help bridge financial gaps and improve the
country’s overall capital stock. Gharti (2023) also highlights that the development of
infrastructure and policies conducive to foreign investment is critical to leveraging the
full benefits of FDI. This is consistent with the findings of Alfaro et al. (2004), who noted
that the positive effects of FDI on economic growth are highly dependent on a country’s
absorptive capacity, which includes institutional frameworks, governance, and
infrastructure. Despite the positive long-term impact of FDI, Gharti (2023) points out that

26
the short-term relationship between FDI and RGDP in Nepal is weak. This suggests that
the open economy and Nepal’s trade dependence on India may be factors that delay the
tangible benefits of FDI. Previous research by Poudel (2019) also observed similar trends
in Nepal, where the lack of adequate infrastructure, political instability, and insufficient
policy measures hinder the potential of FDI to yield immediate economic benefits.

In conclusion, while FDI plays a significant role in enhancing Nepal’s economic

growth, its benefits are more pronounced in the long run. The study by Gharti (2023)
calls for policies that foster a favorable environment for FDI inflows. It emphasizes the
need for strategic investment policies, improved infrastructure, and better governance to
maximize the positive impact of FDI on Nepal’s economic growth. This supports the
recommendations of earlier studies, such as those by Lall (2004) and Puri (2017), who
argue that the effectiveness of FDI is contingent on the country’s investment climate and
institutional quality.

Chhetri's (2022) article, "Foreign Trade, Foreign Direct Investment, and

Economic Growth in Nepal," explores the intricate relationship between foreign trade,
foreign direct investment (FDI), and economic growth in Nepal using time series data
from 1995 to 2020. The study employs the ARDL bound test approach to co-integration
to examine both the long-run and short-run interactions between these variables. The
research reveals a significant co-integration among foreign trade, FDI, and economic
growth, indicating a robust relationship between these factors. Chhetri (2022) finds that
both foreign trade and FDI positively influence economic growth in Nepal. Specifically,
FDI contributes to economic growth by providing long-term capital, introducing new
technologies, managerial expertise, and marketing capabilities. These contributions lead
to enhanced employment opportunities, skill development, technological diffusion, and
innovation, thereby accelerating economic growth (Chhetri, 2022).

In addition to the positive impact of FDI, the study highlights that foreign trade
also plays a crucial role in Nepal's economic growth. Chhetri (2022) demonstrates that
foreign trade positively impacts GDP in the long run by facilitating technology transfer,
capital accumulation, and economies of scale. The importation of advanced production

27
technologies and the ability to access international markets through exports remove
foreign exchange barriers and stimulate economic growth (Chhetri, 2022). The study's
findings underscore the importance of both FDI and foreign trade in fostering Nepal's
economic development. The positive interactions between these variables suggest that
policy measures promoting foreign trade and attracting FDI could significantly enhance
Nepal's economic growth.

Poudel (2022) investigates the effects of Foreign Direct Investment (FDI) on the
economic growth of Nepal using data spanning from 1995 to 2020. Published in the
Journal of Balkumari College, this study employs descriptive and analytical research
designs, utilizing secondary data from Nepal Rastra Bank and the Ministry of Finance.
The analysis is conducted using E-Views Statistical Package version 10, with Augmented
Dickey-Fuller Test for stationarity and Johansen Co-integration Test to explore long-run
relationships (Poudel, 2022).

The study finds that while the Johansen Co-integration Test supports the existence
of co-integration in the model, the Vector Error Correction Model (VECM) shows a
positive but insignificant coefficient, indicating no long-run relationship between FDI
and GDP (Poudel, 2022). However, short-run causality is observed between Gross Fixed
Capital Formation (GFCF) and GDP, with the Granger Causality Test revealing
bidirectional causality between GFCF and GDP, and one-way causality from GDP to
FDI. This suggests that GFCF and GDP influence each other significantly, while GDP
has a unidirectional impact on FDI (Poudel, 2022).

The findings indicate that 78.53% of GDP variation is explained by GFCF, while
FDI does not show a significant association with GDP. This result contradicts theoretical
expectations, which typically predict a positive relationship between FDI and GDP
growth (Poudel, 2022). The study attributes the insufficient impact of FDI and GFCF on
economic growth to policy barriers and political instability, suggesting that Nepal needs
more investment-friendly policies and a stable environment to attract FDI and enhance
GFCF (Poudel, 2022).

Thapa (2022) investigated the impact of FDI on employment generation in

28
Nepal’s industrial sector, covering the period from 1991 to 2020. The study used a
variety of statistical techniques, including Ordinary Least Squares (OLS), Unit Root tests,
Vector Auto-Regression (VAR) models, and the Granger Causality test. The findings
revealed no sustained correlation between FDI and employment generation in Nepal,
which suggests that FDI has not had a significant or lasting impact on job creation in the
country. The study concluded that the relatively small and volatile nature of FDI in
Nepal, coupled with other structural issues in the economy, has limited the potential of
foreign investment to generate substantial employment. While FDI is expected to create
jobs and stimulate industrial growth, its limited scope and inconsistency in Nepal have
hindered its effectiveness in achieving these objectives.

Parajuli (2021) explores the impact of Foreign Direct Investment (FDI) on

economic growth in Nepal, utilizing data from 1990/91 to 2019/20. The study employs
the Ordinary Least Squares (OLS) model to analyze the relationship between FDI inflows
and Gross Domestic Product (GDP). The research aims to assess how FDI influences
Nepal's economic growth and to provide insights into the dynamics of foreign investment
in the country. The study finds a significant long-term relationship between FDI and
economic growth, indicating that increased FDI inflows positively impact Nepal's GDP
(Parajuli, 2021). Parajuli (2021) highlights that FDI contributes to economic growth by
introducing new technologies, management techniques, and financial resources, which
enhance productivity and stimulate economic development. The research also
underscores that Nepal’s favorable tax policies and business environment attract foreign
investors, demonstrating the importance of a stable political and economic climate in
promoting FDI.

The analysis reveals that a positive economic performance signal increased FDI
inflows, reinforcing the notion that FDI serves as a crucial driver of economic growth
(Parajuli, 2021). The study suggests that to further attract FDI, Nepal should focus on
improving infrastructure, security, and governance, emphasizing the need for transparent
and effective resource management. Parajuli’s (2021) findings advocate for policies that
enhance FDI attractiveness and implementation strategies to foster sustained economic
growth. The research provides valuable insights for policymakers aiming to leverage FDI

29
for economic development and highlights areas for improvement in Nepal’s investment
climate.

Pradhan and Phuyal (2020) investigate the impact of foreign aid on Nepal’s
economic growth using time series data from 1975/76 to 2015/16. Published in the
International Journal of Finance and Banking Research, this study aims to evaluate how
foreign aid influences Gross Domestic Product (GDP) and to assess whether the
relationship between foreign aid and GDP has undergone any structural changes over the
decades (Pradhan & Phuyal, 2020). The authors employ a partial adjustment model and
conduct a Chow test to analyze the relationship between foreign aid and GDP,
considering additional variables such as remittances, investment, labor force, and lagged
GDP. Their findings indicate a positive but statistically insignificant relationship between
foreign aid and GDP. This suggests that while foreign aid does contribute positively to
the economy, its impact is limited because it is predominantly directed toward
humanitarian and social welfare rather than productive sectors (Pradhan & Phuyal, 2020).

The study also highlights that the priorities of foreign aid have shifted away from
production toward non-production sectors, such as social services, which has lessened its
impact on GDP growth. Furthermore, the authors note that while foreign loans have
increased significantly, foreign grants have not kept pace, leading to a growing debt
burden (Pradhan & Phuyal, 2020). Remittances, although negatively related to GDP, do
not significantly affect the growth, possibly due to their use in consumption rather than
investment. In contrast, labor force and lagged GDP have a significant positive impact on
GDP, indicating that increased labor and past GDP contributions are beneficial for
current economic growth (Pradhan & Phuyal, 2020). Overall, the study underscores the
need for policymakers to allocate foreign aid more effectively toward productive sectors
and human capital development to enhance economic growth. It also suggests that despite
various reforms and economic liberalization efforts, Nepal has not experienced a
structural breakthrough in its economic development (Pradhan & Phuyal, 2020).

Ghimire, Shah, and Phuyal (2020) explore the macroeconomic determinants of

economic growth in Nepal, analyzing data from 1990 to 2016. Published in the Journal of

30
World Economic Research, this study employs multiple linear regression, Karl Pearson's
correlation, and trend analysis to examine the impact of variables such as exchange rate,
export, foreign direct investment (FDI), gross fixed capital formation (GFCF), import,
and inflation on Nepal's Gross Domestic Product (GDP) growth (Ghimire, Shah, &
Phuyal, 2020). The study reveals that among the variables analyzed, exchange rate,
GFCF, and import have a significant impact on Nepal's economic growth. Specifically,
the exchange rate, GFCF, and import demonstrate a significant positive relationship with
GDP growth, while export, FDI, and inflation do not show a statistically significant
impact (Ghimire et al., 2020). The authors find that a stable exchange rate contributes to
lower production costs and helps manage inflation by reducing the prices of foreign
goods, which in turn influences economic growth positively (Ghimire et al., 2020).

In their cross-country comparison, the study highlights that while Bangladesh and
India exhibit significant positive GDP growth trends, Bhutan and Sri Lanka show
positive but non-significant growth. Conversely, China, Nepal, and Pakistan experience
negative growth trends. The authors suggest that Nepal's reliance on imports and the
pegged exchange rate regime with the Indian currency complicate efforts to create a
stable business environment conducive to growth (Ghimire et al., 2020). The study
recommends that Nepal should focus on reducing its dependency on imports by
enhancing domestic production and agricultural output. Additionally, increasing
investment in infrastructure and implementing measures to control inflation are suggested
to foster economic growth (Ghimire et al., 2020). The authors advocate for policy
measures to improve economic stability and growth prospects by optimizing GFCF and
maintaining a favorable exchange rate.

Kaphle (2020) explores the relationship between foreign exchange reserves and
economic growth in Nepal using time series data spanning from 1975 to 2018. Published
in Journal of Management and Development Studies, the study employs various
statistical methods, including unit root tests, cointegration tests, and the Vector Error
Correction Model (VECM), to analyze the impact of foreign exchange reserves on
Nepal's economic growth (Kaphle, 2020). The research reveals a long-term relationship
between foreign exchange reserves and economic growth, as indicated by the Johansen

31
cointegration test. The VECM results and Wald statistics suggest that past values of
foreign exchange reserves positively contribute to economic growth in Nepal (Kaphle,
2020). This finding underscores the importance of maintaining adequate foreign
exchange reserves as a tool for promoting economic stability and growth. Kaphle’s study
provides valuable insights into how foreign exchange reserves can influence economic
performance. It highlights the positive impact of reserves on economic growth,
suggesting that effective management of these reserves is crucial for sustaining economic
development in Nepal (Kaphle, 2020).

Neupane (2020) focused on the sectoral impact of FDI in Nepal, particularly

examining the number of projects, employment generation, and the volume of
investments. The study used a descriptive research design and secondary data from the
Ministry of Industry for the period from fiscal year 2066/067 to 2075/076. The analysis
revealed that FDI’s impact on capital formation and employment generation in Nepal was
minimal. Although FDI brought new technologies, financial resources, management
expertise, and market access, particularly to the manufacturing and transportation sectors,
its overall contribution to GDP growth was limited. This suggests that while FDI plays an
important role in bringing technological advancements and financial resources, it has not
significantly contributed to employment creation or capital accumulation in Nepal’s
economy. The findings indicate that FDI, while beneficial in some sectors, has not been
sufficient to trigger substantial economic growth or development.

Kharel (2020) examined the broader impact of FDI on employment in Nepal,

particularly in the context of the country's foreign investment climate. The study, which
covered the period from 2000/01 to 2018/19, employed a descriptive research design and
multiple regression analysis. The results indicated a significant positive relationship
between FDI and employment, with FDI accounting for approximately 16% of
employment growth. Despite this positive correlation, the study highlighted that the
overall perception of FDI in Nepal remains negative. The study pointed out that while the
government offers attractive incentives and liberal policies to attract foreign investment,
these efforts have not been sufficient to change the negative perception of FDI. The
findings also suggested that the liberal policy environment alone is not enough to attract

32
significant foreign capital, and improvements in the investment climate—such as
reducing political instability, enhancing infrastructure, and strengthening public
institutions—are necessary for Nepal to fully benefit from FDI.

Chaudhari et al. (2020) explored the impact of the COVID-19 pandemic on FDI
inflows into Nepal and the obstacles to FDI commitment during this period. The study,
which used secondary data and a descriptive research design, found that the pandemic
had a significant negative impact on FDI inflows, as the global health crisis created
several barriers to investment. The study highlighted that the pandemic not only delayed
foreign investment commitments but also posed challenges in the implementation of
ongoing projects. The Nepalese government’s prioritization of sectors such as
infrastructure, information technology (IT), energy, tourism, and agriculture was seen as
essential for attracting FDI. However, the study noted that the pandemic hindered
progress in these areas, further limiting FDI inflows during this period. The research
underscored the importance of sectoral diversification and government support to
mitigate the effects of external shocks on FDI.

Kharel and Kharel (2019) provide an in-depth analysis of the status and impact of
Foreign Direct Investment (FDI) in Nepal, focusing on its role in economic development.
Published in Molung Educational Frontier, the paper underscores the significant
contribution of FDI to Nepal's economic advancement, particularly since the country
adopted liberal economic policies in the 1990s. The Foreign Investment Technology
Transfer Act (FITTA) has been pivotal in enhancing the investment environment (Kharel
& Kharel, 2019). The study applies a simple linear regression model to evaluate the
impact of FDI on Nepal’s GDP and employment from 1990/91 to 2018/19. Findings
reveal a positive impact of FDI on these macroeconomic indicators, suggesting that FDI
plays a beneficial role in boosting economic growth and creating jobs in Nepal (Kharel &
Kharel, 2019). Despite these benefits, the authors note that the FDI environment in Nepal
remains moderate, affected by policy inefficiencies and a lack of effective monitoring
systems.

The authors argue that while liberal economic policies and incentives have been

33
introduced, Nepal's attractiveness as an investment destination is not as competitive
compared to its neighboring countries. The study advocates for a more targeted approach
to FDI, improved information systems, and further research to better understand FDI's
comprehensive impact on Nepal’s economy, including GDP, employment, revenue
mobilization, export promotion, and entrepreneurship development (Kharel & Kharel,
2019).

Paudel and Acharya (2019) examine the relationship between financial

development and economic growth in Nepal using the Autoregressive Distributed Lag
(ARDL) approach to cointegration, based on time series data from 1965 to 2018.
Published in Journal of Development and Economic Studies, the study aims to shed light
on how various dimensions of financial development impact economic growth in a
developing country like Nepal, which has recently undergone significant political
changes and is striving to attract foreign direct investment (Paudel & Acharya, 2019).
The authors utilize five proxies of financial development: broad money, domestic credit
to the private sector, total credit from the banking sector, capital formation, and foreign
direct investment. They assess their contributions to economic growth and include trade
openness and the working-aged population as control variables. The study finds that
financial development indicators such as broad money, domestic credit to the private
sector, and credit from the banking sector significantly contribute to economic growth,
whereas foreign direct investment does not show a statistically significant impact (Paudel
& Acharya, 2019).

The results suggest that while financial development generally supports economic
growth, foreign direct investment’s role is less clear, indicating a need for policies that
enhance the attractiveness of Nepal as an investment destination. Additionally, the study
highlights that trade openness has an ambiguous effect, and the working-aged population
shows a negative impact on growth, contrary to expectations (Paudel & Acharya, 2019).
Overall, the study provides valuable insights into the importance of financial
development for economic growth in Nepal and suggests that extending financial
activities could potentially boost growth. However, it also notes limitations, such as the
absence of a composite financial development index, which could offer a more

34
comprehensive analysis (Paudel & Acharya, 2019).

Pokharel and Pokharel (2019) conducted a study to explore the impact of FDI on
Nepal's economic growth by employing the Granger causality test and multiple
regression analysis. The study spanned from 2008/09 to 2017/18, using data from the
Nepal Rastra Bank (NRB) and the Government of Nepal’s economic surveys. The study
found a positive and significant relationship between FDI, Gross Domestic Product
(GDP), and gross fixed capital formation. This suggests that FDI has a beneficial role in
enhancing economic growth and contributing to capital formation in the economy.
Despite this, the Granger causality test revealed that there was no direct causal
relationship between these variables. This implies that while FDI and economic growth
are positively correlated, other factors such as domestic policies, political stability, and
institutional quality may play a crucial role in shaping the economic outcomes. The
authors also emphasized the need for the government to address various challenges,
including political instability, corruption, weak public institutions, and a negative public
image, which hinder FDI inflows into Nepal. These factors need to be mitigated to foster
a more conducive environment for foreign investment.

Studies on foreign trade, FDI, and economic growth in Nepal highlight various
impacts and challenges. Research indicates that foreign trade and FDI generally have a
positive effect on economic growth, though the relationship can be complex. For
instance, while exports and total trade volume positively influence GDP, FDI's effects are
often more pronounced in the long term. Specific sectors like agriculture benefit notably
from FDI. However, challenges such as political instability, policy inefficiencies, and
inadequate infrastructure can hinder the effectiveness of FDI. Studies suggest that
improving the business environment, reducing reliance on imports, and enhancing
domestic production are crucial for maximizing the benefits of foreign trade and
investment. Additionally, foreign aid and financial development also play significant
roles in supporting economic growth, though their impact can be limited by various
factors. Overall, targeted policies and improvements in governance are recommended to
boost Nepal's economic development through trade and investment.

35
2.2 Research Gap

While existing literature provides valuable insights into the relationship between
FDI and economic growth, gaps remain in understanding the sector-wise impacts and
asymmetric effects of FDI in Nepal. Previous studies have primarily focused on
aggregate data, overlooking the nuanced contributions of specific sectors. Moreover, the
short- and long-term dynamics of FDI’s impact require further exploration using
advanced econometric models such as NARDL. While several studies indicate a positive
correlation between FDI and GDP, they often fail to differentiate the effects across
various sectors, such as agriculture, manufacturing, and services. This oversight limits the
potential for tailored policy interventions that could optimize FDI benefits in specific
areas of the economy, where the contributions of FDI may vary significantly.

Furthermore, existing research predominantly utilizes aggregated data without

considering the nuanced effects of FDI on GDP growth over time. This approach may
obscure important trends and the effectiveness of FDI in stimulating economic
development in Nepal. For instance, while FDI is generally linked to long-term economic
growth, the literature does not adequately address the short-term fluctuations and sectoral
performance that could inform a more comprehensive understanding of FDI's role in
Nepal’s economy. As such, a deeper investigation into the sector-wise trends of FDI
inflows is necessary to illuminate their varying impacts on economic growth.

Finally, many studies highlight the broader economic environment, including

factors like political stability and infrastructure, as critical determinants of FDI's
effectiveness. However, there is limited empirical analysis that integrates these contextual
elements with sector-specific FDI data and GDP outcomes. This lack of integration
hinders the formulation of effective policies that could address both the macroeconomic
and sectoral challenges facing Nepal. Therefore, this study aims to fill these gaps by
analyzing the sector-wise trends of FDI inflows and their specific impacts on GDP,
providing valuable insights for policymakers and stakeholders in enhancing the
investment climate and fostering sustainable economic growth in Nepal.

36
 CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter will outline the research methodology employed in the study,
detailing the processes from data collection to analysis techniques. It will provide a
comprehensive overview of the data utilized and the statistical methods applied. The
section will cover the research methods, models, variables, data sources, and the
analytical techniques used, including the software applied for analysis. Research methods
will be broadly categorized into quantitative and qualitative approaches. Qualitative
research, unlike quantitative, will deal primarily with non-numerical data, which will be
interpreted by the researcher. Techniques such as one-on-one interviews, focus group
discussions, ethnographic research, case studies, record keeping, and process observation
will be employed in qualitative research (Gray, 2014; Hancock, 2009; Methods and
Time, 2000). On the other hand, quantitative research will involve collecting numerical
data and analyzing it with statistical techniques to derive definitive conclusions. Data for
quantitative research will typically be gathered through closed-ended questionnaires or
secondary sources like books, journals, published research papers, and databases from
international organizations such as the World Bank and IMF (The World Bank, 2014;
The World Bank Group, 2015). This study will adopt the quantitative research method, as
previous research has demonstrated its effectiveness in establishing long-term
relationships and deriving conclusive results.

3.2 Conceptual Framework

Independent Variables Dependent Variable

Foreign Direct Investment Economic growth

Figure 3.1 Conceptual Framework

37
3.3 Research Design

This study employs a quantitative research design to analyze the relationship

between Foreign Direct Investment (FDI) inflows and Gross Domestic Product (GDP) in
Nepal. This study adopts a descriptive and analytical approach. It focuses on two
objectives: examining sector-wise trends of FDI inflows and assessing their impact on
economic growth, and analyzing the asymmetric effects of FDI on GDP using
econometric models.

Descriptive statistics and visualization tools such as line graphs and bar charts are
used to analyze sector-wise FDI trends across key sectors, including manufacturing,
services, agriculture, and energy. To quantify the sectoral impacts of FDI on economic
growth, panel data regression is applied, with model selection guided by the Hausman
test.

For asymmetric analysis, the Nonlinear Autoregressive Distributed Lag (NARDL)

model is used to examine the differential effects of positive and negative FDI changes on
GDP. The analysis includes stationarity tests, diagnostic checks, and Impulse Response
Functions (IRFs) to ensure robust findings. This design offers a comprehensive
understanding of FDI's role in Nepal’s economic development.

3.4 Nature and Source of Data

The research utilized a descriptive, analytical, and statistical approach, analyzing

time series data from fiscal years 1994 to 2024. The data encompassed various aspects,
such as approved FDI, actual FDI, percentage changes in GDP growth rate and FDI
inflow, and sector-wise breakdowns. These data were obtained from government sources
like the NRB, MOF, MOI, and CBS. When necessary, the data were transformed using
logarithmic methods to facilitate analysis. The use of secondary data and established
econometric techniques ensured a robust examination of the relationship between FDI
inflows and economic growth in Nepal.

38
3.5 Sample Size

The study covered a sample size spanning fiscal years 1994to 2023, providing 30
years of observational data. Data were sourced from various government bodies, such as
the Nepal Rastra Bank (NRB), Ministry of Finance (MOF), Ministry of Industry (MOI),
World Bank, and Central Bureau of Statistics (CBS) Nepal. The sample size was a
critical aspect of the empirical research, as it determined the statistical power and the
ability to make inferences about the broader population. In this study, the sample
included annual data points across multiple variables, providing a comprehensive view of
the period under analysis

3.6 Tools of Analysis

This study utilizes a combination of statistical and econometric methods to

analyze the relationship between Foreign Direct Investment (FDI) inflows and Gross
Domestic Product (GDP) in Nepal. Two main objectives guide the analysis: assessing
sector-wise trends of FDI inflows and their specific impacts on economic growth, and
examining the asymmetric effects of FDI on GDP using advanced econometric tools.

To evaluate the sector-wise trends of FDI inflows, descriptive statistics and trend
analysis are employed. Time-series data on FDI inflows across key sectors, such as
manufacturing, services, agriculture, and energy, are analyzed. Growth rates, sectoral
shares, and dominant trends are calculated and visualized using tools like line graphs, bar
charts, and sectoral heatmaps. To quantify the impact of FDI on economic growth across
sectors, panel data regression analysis is applied. The panel regression model accounts
for cross-sectional and time-series variations, enabling a robust assessment of the sector-
specific effects of FDI inflows. Fixed effects and random effects models are tested to
determine the most suitable estimation method, with Hausman’s test employed to guide
model selection.

The study further employs the Nonlinear Autoregressive Distributed Lag

(NARDL) model to analyze the asymmetric effects of aggregate FDI inflows on GDP.
This model decomposes FDI into positive and negative changes to capture the differential

39
impacts of FDI increases and decreases on economic growth. The analysis begins with
stationarity testing using the Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP)
tests. The model selection is based on criteria such as the Akaike Information Criterion
(AIC) or Bayesian Information Criterion (BIC). Diagnostics, including serial correlation
tests and stability tests, validate the model, while Impulse Response Functions (IRFs) are
used to visualize the dynamic impacts of FDI [Link] dual approach sectoral trend
analysis and asymmetric econometric modeling ensures a comprehensive understanding
of the relationship between FDI inflows and economic growth in Nepal, providing
evidence-based insights for policy formulation.

3.7 Model Specification

The study employs two distinct econometric models to analyze the relationship between
Foreign Direct Investment (FDI) inflows and Gross Domestic Product (GDP) in Nepal,
focusing on sector-wise trends and asymmetric effects.

For the sector-wise analysis, the panel data regression model is specified as:

GDPit=β0+β1FDIit+β2Xit+εit

Where:

GDPit will represent the economic output of sector ii at time tt,

FDIit will denote FDI inflows in sector ii at time tt,

Xit will include control variables such as labor force participation, trade openness, and
infrastructure investment,

εit will be the error term.

β0 is the intercept term.

β1,β2 are the coefficients of the independent variables.

40
Fixed effects and random effects models are tested to identify the appropriate estimation
method, with Hausman’s test used to select between the two. This model provides
insights into the impact of sector-specific FDI inflows on GDP, accounting for both
sectoral and temporal variations.

For the asymmetric analysis of FDI inflows on GDP, the Nonlinear Autoregressive
Distributed Lag (NARDL) model is specified as:

GDPt=α0+∑ α1iFDIt++∑ α2jFDIt−+∑ α3kZt + εt

Where:

FDIt represent the positive and negative changes in FDI inflows, respectively.

Zt includes other control variables, such as trade openness and infrastructure investment.

α0 is the intercept term.

α1i,α2j,α3k are the short-term coefficients for the independent variables.

εt is the error term.

The NARDL model captures both short-term and long-term asymmetric impacts of FDI
on GDP. Lag lengths are selected using the Akaike Information Criterion (AIC), and
diagnostic tests ensure the model's validity. This specification allows for a nuanced
understanding of how increases and decreases in FDI differentially influence economic
growth.

3.8 Operational Definition of Variable

1. Foreign Direct Investment (FDI)

Foreign Direct Investment refers to investments made by foreign entities in the

form of acquiring ownership or establishing new business operations in Nepal, with the
intent to have a lasting interest and influence in the management of these enterprises. FDI
will be quantified based on annual data of total foreign investment inflows reported by

41
Nepal’s central bank and relevant government agencies. This includes direct investments
in businesses, joint ventures, and greenfield investments in various sectors.

2. Gross Domestic Product (GDP)

Gross Domestic Product is the total monetary value of all finished goods and
services produced within Nepal’s borders over a specified time period. GDP will be
measured using annual data provided by national statistical agencies and international
financial institutions. This will include nominal GDP figures, adjusted for inflation to
reflect real GDP growth.

3. Economic Growth

Economic growth refers to the increase in the production of goods and services in
Nepal, typically measured by the growth rate of GDP. Economic growth will be assessed
using annual percentage changes in real GDP. This will be based on data from national
economic surveys and reports from financial institutions like the World Bank and IMF.

3.9 Methodological Matrix

Research Research Variables Data Data Expected

Objectives Questions Collection Analysis Outcomes
Methods Techniques

To analyze What are Sector- Secondary Descriptive Identification

the sector- the specific FDI data from statistics of sectors
wise trends sectoral inflows World with the
and
of foreign trends of (Independe Bank, highest and
panel
direct FDI nt Variable) UNCTAD, lowest FDI
regression
investment inflows in NRB, inflows in
(FDI) Nepal? Ministry of Nepal.
inflows in Industry
Nepal and
assess their

42
impact on
economic
growth.

To examine What is FDI inflows Data from NARDL Quantification

the the (Independe World of the
Model
relationship relationshi nt Variable) Bank, relationship
between p between UNCTAD, between
foreign FDI Nepal overall FDI
direct inflows Rastra Bank inflows and
investment and GDP GDP growth
(FDI) and growth in in Nepal.
gross Nepal?
domestic
product
(GDP) in
Nepal.

43
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