Effect of institutional quality on FDI inflows in South Asian and Southeast Asian countries

Foreign Direct Investment (FDI) plays a pivotal role in the economic development of countries and institutional quality encompassing aspects such as political stability, regulatory environment, and the rule of law, plays a vital role in attracting and retaining foreign investment. This study investigates the impact of institutional quality on the level of FDI inflows in the South Asian and Southeast Asian countries over the period 2002-2019. We have constructed an institutional quality index by using Principal Component Analysis (PCA) on six governance indicators. Iterated generalized least squares (I-GLS) in the fixed effect model has been employed for the estimation of the results. The results show that the institutional quality index has a positive and significant impact on the FDI inflows in both the regions. This implies that an ideal governance system comprising of low corruption, political stability, absence of violence, voice and accountability, regulatory quality and proper judicial system helps to attract FDI inflows in the South Asian and Southeast Asian countries. It also has positive spillovers to other economic activities such as GDP growth, international trade and financial development that are vital for economic growth and development.