The Effects of Political Instability on Foreign Direct Investment (FDI) in Pakistan

Abstract

This study explores the effects of political instability on Foreign Direct Investment (FDI) inflows in Pakistan, focusing on the role of governance quality, sectorial variation, and the types of FDI most sensitive to political risks. Using a multiple regression analysis, the research analyzes the relationship between political instability, macroeconomic factors, and FDI inflows from 1990 to 2020. The results show that political instability significantly reduces FDI in Pakistan, with a 37% decline in FDI inflows for each unit increase in political instability. Additionally, sectorial analysis reveals that capital-intensive sectors such as energy and infrastructure are less sensitive to political instability, while manufacturing and services sectors experience a stronger negative impact. Governance quality, particularly in terms of the rule of law and corruption control, is found to mitigate the negative effects of political instability, emphasizing the importance of institutional strengthening in attracting foreign investment. Furthermore, different types of FDI—greenfield investments, mergers and acquisitions, and joint ventures—demonstrate varying degrees of sensitivity to political instability, with greenfield investments being the most vulnerable. The study concludes with policy recommendations aimed at improving political stability, strengthening governance institutions, and creating a more favorable environment for foreign investors, particularly in sectors sensitive to political risks. These findings have significant implications for policymakers and foreign investors seeking to navigate political risks in emerging markets like Pakistan.