Foreign Direct Investment, Financial Development, and Sustainable Growth: Empirical Evidence from Developing Countries

Abstract

This research examines the interactive relationship between foreign direct investment and economic progress in Developing Countries, considering the dimensions of sustainability, financial development, and institutional quality. The empirical analysis relies on time-series data and employs econometric techniques, including ordinary least squares, fixed effects, and the generalised method of moments, using panel data from 2008–2024. The findings indicate that foreign direct investment has a statistically significant and positive effect on gross domestic product growth in developing countries. However, this effect is conditional on macroeconomic stability and the presence of well-developed financial institutions. Financial development indicators such as domestic credit to the private sector and market capitalisation also have a positive influence, highlighting the complementary role of finance in leveraging capital inflows. Conversely, inflation and political instability exert a negative impact, emphasising the need for stable policy environments. The study’s contribution lies in its policy relevance for developing countries, recommending the reinforcement of institutional controls, streamlined investment processes, and the adoption of sustainable financing mechanisms such as green and resilience bonds. Incorporating environmental, social, and governance screening in the foreign direct investment approval process is also advised. By strengthening institutional capacity and aligning investments with sustainability objectives, developing countries can fully harness foreign direct investment as a driver of inclusive economic growth. The study concludes that while foreign direct investment has the potential to be transformative, its impact is mediated by the effectiveness of policies, institutional preparedness, and long-term development planning.

Keywords: Foreign Direct Investment, Economic Growth, Financial Development, Institutional Quality