FDI and Stock Market Performance in Sri Lanka: Short- and Long-Run Effects

Purpose: This study investigates the impact of foreign direct investment (FDI) on stock market performance in Sri Lanka, emphasizing both short-run and long-run dynamics. Given the mixed findings in prior studies, this research provides an updated and detailed analysis.
Design/Methodology/Approach: The study accompanies quarterly data from 2003 to 2023. To analyze long-term and short-term components, it applies Johansen cointegration tests and the Vector Error Correction Model (VECM), with additional dynamic analysis tools including Granger causality tests, variable decomposition and impulse response functions. The empirical analysis is conducted using EViews software, incorporating key economic control variables such as interest rates, inflation, dependent growth, nominal monetary rates and exchange rates.
Findings: The study reveals a significant long-run relationship between FDI and stock market performance, emphasizing the role of FDI in the long-term development of the Colombo Stock Exchange. GDP shows a weak negative connection, while inflation, interest rates and exchange rates have positive long-run relationships with stock market performance. In the short run, FDI does not have a significant impact on stock market performance. However, the analysis shows that over time, FDI has a positive effect on the stock market although its contribution to short-term performance is limited.
Originality: This study provides updated evidence from Sri Lanka showing that FDI is a key driver of long-term stock market development and in the short term the impact is less pronounced. The findings provide valuable implications for policymakers and investors to understand the dynamic role of FDI in Sri Lanka.