Foreign Direct Investment, Financial Development and Political Risks

Financial development is definitely a determinant of the extent of foreign direct investment (FDI) inflow into an economy. Yet, the contribution of financial development (FD) can be dependent on the political situation of the recipient nation. Higher political stability aids financial institutions to reap the benefits of FDI efficiently. Our paper empirically investigates the role of political risk in the association of FDI and FD. Using a panel of 97 countries, we show the relationship to be strictly non-linear. The impact of FD on FDI becomes negative beyond a threshold level of FD. However, we do find political risk factors to be affecting the relationship by altering the threshold level of financial development.