Effect of foreign direct investment on balance of payment in Uganda

Abstract

The study used multivariate vector autoregressive model (VAR) to investigate the impact of foreign direct investment (FDI) on balance of payments and assess the determinants of FDI inflows in Uganda for the periods between 1970 and 2010. Interpretations of results are based on Granger-Causality and innovation accounting (variance decomposition and impulse response functions). The study finds that international capital flows are of great importance in stimulating economic growth in Uganda. Results further revealed that the determinants of FDI inflows are domestic investments, growth in Gross Domestic product (GDP), growth in exports and imports; however import and export growth are not very impactful as compared to the rest of the variables in generating FDI inflows. The study detected three different channels through which FDI inflows impacts on economic growth in Uganda. The first one is direct transmissions from FDI to GDP growth. The second channel is indirectly through domestic investments and by multiplier process, higher level of economic growth is generated. The third channel is through exports thereby yielding export-led growth. The findings suggest different policy implications among which includes improvement in business climate to attract more FDIs; promotions of import substitution and export promotion strategies of industrialization; need for government involvement in sectoral distributions of FDIs; and facilitating technological transfers by building absorptive capacity for local firms through manpower development, collaborative research and development.