Political Risk and Foreign Direct Investment: A Focus on Msci Frontier Market Economies

Abstract

This study examines the impact of political risk on Foreign Direct Investment (FDI) in Frontier Market Economies (FMEs) from 2002 to 2023 for a period of 22 years. It considers three World Governance Indicators (WGI), of World Bank (WB): Political Stability and Absence of Violence/Terrorism (PSAV), Rule of Law (RL), and Voice and Accountability (VA), along with other macroeconomic variables: market size, development level, trade openness and infrastructure using fixed effect regression method. The result of the study shows that trade openness and market size exert positive and statistically significant effect on FDI, while development level exerts negative and statistically significant effect on FDI in the FMEs. Infrastructure variable shows insignificant effect. Contrary to conventional expectations PSAV shows negative and statistically significant effect on FDI inflow in FMEs, suggesting that when economic returns are high, foreign investors may tolerate political risk. Other political risk variables, including RL and VA, were found insignificant in FMEs. Empirical findings of the research shows that macroeconomic variables dominate political risk variables in attracting FDI in FMEs, highlighting their primary role in driving the FDI and providing important policy insights for frontier market economies.

Keywords:

Political Risk, FDI, Frontier Market Economies.

JEL Classification Codes: C330, F210