Stylized illustration of FDI inflows in South Asia

Decoding FDI in South Asia: What Drives Investment and Growth?

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Nico Varela in Business & Economy December 2025 • 4 min read.

"Uncover the key factors attracting foreign investment to South Asian economies and how it fuels growth."


In the evolving landscape of global economics, South Asia has emerged as a region of increasing interest for foreign direct investment (FDI). Following widespread liberalization policies in the 1990s and early 2000s, countries like India, Pakistan, Bangladesh, and Sri Lanka have captured the attention of developed and emerging economies alike. This surge in interest has led to a significant increase in FDI inflows, prompting researchers and policymakers to examine the impact and determinants of this investment on South Asian economies.

This analysis delves into the factors influencing FDI in South Asia and its subsequent effects on economic growth. It examines two primary aspects: first, it identifies the key determinants of FDI inflows into South Asian countries using a gravity model equation. Second, it assesses the growth effects of FDI, employing a growth model to understand how foreign investment contributes to economic expansion in the region.

By employing panel data analysis and the Arellano-Bond dynamic panel system method, this study aims to provide a comprehensive understanding of the dynamics between FDI and economic growth in South Asia. The findings offer valuable insights into the factors that attract foreign investment and its role in fostering economic development.

What Factors Attract FDI to South Asia?

Stylized illustration of FDI inflows in South Asia

Understanding the drivers behind FDI inflows is crucial for South Asian economies aiming to maximize the benefits of foreign investment. Several factors play a significant role in determining the attractiveness of these countries to foreign investors. These include robust growth levels, a thriving service sector, large domestic markets, and policy reforms that favor FDI. Countries that demonstrate sustainable growth and offer favorable conditions are more likely to attract substantial foreign investment.

Research indicates that host country policies significantly influence FDI flows by shaping the advantages of locating investments within those countries. Factors such as corporate tax rates, tariff rates, openness to international capital flows, and the effectiveness of contract enforcement all play a role. Additionally, elements like nationalization risk, bureaucratic efficiency, and levels of corruption can also impact investment decisions. These institutional and policy variables collectively determine the investment climate and, consequently, the flow of FDI.

  • Economic Stability and Growth: Consistent economic growth signals stability and potential returns, attracting investors seeking long-term opportunities.
  • Market Size and Potential: Large domestic markets offer economies of scale and access to a significant consumer base.
  • Policy Environment: Open and transparent policies, coupled with efficient regulatory frameworks, foster investor confidence.
  • Infrastructure Development: Adequate infrastructure, including transportation, communication, and energy, is essential for supporting business operations.
  • Skilled Labor Force: Access to a skilled and adaptable workforce enhances productivity and innovation.
The dynamics of currency exchange rates also play a pivotal role in FDI decisions. For instance, studies have shown that the devaluation of a country's currency can improve its competitiveness in attracting foreign direct investment. This is because devaluation can make the country's goods and services cheaper for foreign investors, thereby increasing the attractiveness of investments in export-oriented industries. Furthermore, the real exchange rate between different currencies can significantly influence investment decisions, particularly for investors from countries with stronger currencies.

The Road Ahead: Maximizing FDI for Sustainable Growth

In conclusion, understanding and leveraging the determinants of FDI are crucial for South Asian countries aiming to achieve sustainable economic growth. By focusing on creating stable economic environments, implementing investor-friendly policies, and developing robust infrastructure and human capital, these nations can attract greater foreign investment. Moreover, addressing challenges such as corruption and bureaucratic inefficiencies is essential to enhance investor confidence and ensure that FDI contributes effectively to economic development. As South Asia continues to integrate into the global economy, strategic management of FDI will play a vital role in shaping its future prosperity.

About this Article -

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Everything You Need To Know

1

What specific factors attract Foreign Direct Investment (FDI) to South Asian countries?

Several factors attract Foreign Direct Investment (FDI) to South Asia. These include consistent economic growth, a thriving service sector, and large domestic markets. Additionally, policy reforms that favor FDI, open and transparent policies, efficient regulatory frameworks, and adequate infrastructure development, including transportation, communication, and energy, are essential. A skilled labor force also enhances productivity and innovation. Currency exchange rates, such as the devaluation of a country's currency, can improve competitiveness and make goods and services cheaper for foreign investors. The real exchange rate also influences investment decisions.

2

How do host country policies impact Foreign Direct Investment (FDI) inflows?

Host country policies significantly influence Foreign Direct Investment (FDI) flows by shaping the advantages of locating investments within those countries. Corporate tax rates, tariff rates, and openness to international capital flows play a significant role. The effectiveness of contract enforcement is crucial, as are considerations like nationalization risk, bureaucratic efficiency, and levels of corruption. These institutional and policy variables collectively determine the investment climate and, consequently, the flow of FDI.

3

What role does economic stability and growth play in attracting Foreign Direct Investment (FDI) to South Asia?

Economic stability and growth are critical drivers for attracting Foreign Direct Investment (FDI). Consistent economic growth signals stability and potential returns, attracting investors seeking long-term opportunities in South Asian economies. This includes factors such as the size of domestic markets and the potential for economies of scale, making these countries attractive investment destinations. These factors collectively enhance investor confidence and contribute to a favorable investment climate.

4

How can South Asian countries maximize Foreign Direct Investment (FDI) for sustainable economic growth?

South Asian countries can maximize Foreign Direct Investment (FDI) for sustainable economic growth by focusing on creating stable economic environments. This involves implementing investor-friendly policies, developing robust infrastructure, and investing in human capital. Addressing challenges like corruption and bureaucratic inefficiencies is also essential to enhance investor confidence. Strategic management of FDI plays a vital role in shaping South Asia's future prosperity as it integrates further into the global economy. Open and transparent policies, efficient regulatory frameworks, and adequate infrastructure are all pivotal.

5

How does the currency exchange rate influence Foreign Direct Investment (FDI) decisions in South Asia?

Currency exchange rates play a pivotal role in Foreign Direct Investment (FDI) decisions in South Asia. Studies show that the devaluation of a country's currency can improve its competitiveness in attracting FDI. This is because devaluation makes the country's goods and services cheaper for foreign investors, increasing the attractiveness of investments in export-oriented industries. Moreover, the real exchange rate between different currencies can significantly influence investment decisions, particularly for investors from countries with stronger currencies. These dynamics influence the cost of investment and potential returns.

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