1.

INTRODUCTION
It is generally accepted that Foreign Direct Investment (FDI) is a key driver in promoting
long-term economic growth, particularly in a developing countries, that have experienced a
shortage of capital accumulation for their development. Developing countries are highly
dependent on FDI as a mechanism of economic growth and have been trying to attract
foreign investors, particularly Multinational Enterprises (MNEs), by reducing barriers to
FDI and offering various tax incentives and subsidies.
Malaysia is one of the countries in Asia that has benefited from strong FDI inflow. The
economy relied on the foreign fund as a major source of capital, modern technology and
technical skills. Globalization, international financial integration and expansion of global
production have intensified FDI in the past decades.
FDI enables the investing firm to utilize their specific assets such as technologies and
managerial know-how. Thus, FDI brings benefits in various aspects, which are source of
funds in term of capital stock; increase in employment, income and growth, as well as in
skills and technology.
This paper identifies some of the main factors that contribute significantly to attracting
FDI in Malaysia. This is crucial because private investment has been given a leading role
to bring the economy to higher growth and sustainable economy.

1. FACTORS THAT AFFECT MALAYSIAS FOREIGN DIRECT INVESTMENT

INFLOWS
Past studies show that here is an importance of foreign capital in expanding the economic
growth of a country. Although there are many factors that affect the FDI inflow of
Malaysia, this paper will focus on four determinants that are most significant. The four
determinants are the market size, trade openness, economic growth and inflation rate of the
host country

1.1. Market Size

Market size measured by gross domestic product plays an important role in this study
because it indicates how well a countrys population demand for the output. It is important
for foreign investor to determine whether to invest or not from the view of market
opportunity.
A larger market size will attract investors with ease. A large market size means the
resources of the country will be utilized more efficiently and exploitation of economies of
scale. Hence, it is the key for investors who aim for long term investment.
The importance of the market size has been confirmed in many past literatures as the host
market size represents the host countrys economic condition and the potential demand for
their output. Previous researchers like Quer and Claver (2007), concluded that the market
demand and market size, indicated by the variable of gross domestic product (GDP) is
significant and positively affects Malaysia foreign direct investment inflows. This proves
that Malaysia FDI inflows will increase given the level of gross domestic product increase.

1.2. Trade Openness

Openness to trade refers to the degree to which countries engage in trading activities with
other countries or economies. Both developed and developing economies depend more on
international trade as openness to trade is used extensively in the economic growth
literature as a major determinant of growth performance.
A countrys willingness to accept foreign direct investment is important to the FDI of that
particular country. The impact of openness on FDI depends on the type of investment.
When investments are market-seeking, trade restrictions (and therefore less openness) can
have a positive impact on FDI. foreign firms that seek to serve local markets may decide to
set up subsidiaries in the host country if it is difficult to import their products to the
country. In contrast, multinational firms engaged in export-oriented investments may
prefer to invest in a more open economy since increased imperfections that accompany
trade protection generally imply higher transaction costs associated with exporting.

Past literatures and studies argued that the impact of the openness in host countrys
economy is expected to be mixed but generally this variable in the conventional findings
tends to be positively associated with the FDI inflows. Based on the results by Moosa and
Cardak (2006), trade openness was verified to be significant and have a positive effect on
the inflows of FDI.

1.1. Economic Growth

A higher rate of economic growth signals the size of the potential market, which could be
expanded in the future. Economic growth motivates foreign firms to plan new projects or
new production facilities. Regions that are experiencing rapid economic growth are also
generating more profitable opportunities, and they give the promise of growing markets
and growing profits.
Growing economies provide growing prospects for profitable investments. Where FDI is
attracted by economic growth it will tend to be targeted at the recipient nations domestic
market rather than for exports. The size of the recipients market can be particularly
important for horizontal FDI where economies of scale are especially important. Growth,
however, is unlikely to be important for vertical FDI.
A countrys economic growth has been identified frequently by scholars as an important
determinant of FDI inflow into the host countries. Chakraboty and Basu (2002) argues that
MNCs with certain ownership advantages will invest in another country with locational
advantages, and both advantages can be captured effectively by internalizing production
through FDI. Thus, high GDP growth rate which represents soundness and stability of
economic policies and the effectiveness of the government institutions will definitely
attract foreign direct investment as it allows them to locate new profit opportunities.

1.1. Inflation
This research concluded that inflation rate is a significant determinant of Malaysia FDI
inflows. Based on the result, there is a positive relationship between inflation rate and
Malaysia FDI inflows as supported by past researchers like Srinivasan (2011) and Addison
and Heshmati (2003). In the past research paper, Addison and Heshmati (2003) mentioned
that higher inflation rate indicates higher price levels which may lead to the increased
production activities of the host country. This then will attract more foreign firms to invest
in the host country for the increased expected level of profitability. In addition, as stated by
Srinivasan (2011), higher inflation may lead to an increase in product price, which in turns
decrease the demand for host countrys money. As currency of host country depreciates, it
attracts larger FDI inflows into Malaysia since its capacity to invest is increased through
the reduced cost of capital. On the other hand, the results are found to be inconsistent with
the some of the past researches done. Despite researchers like Shamsuddin (1994), Asiedu
(2002), Demirhan and Masca (2008), and Azam (2010) have proven inflation rate to be

statistically significant to the FDI inflows, it is also found that there is a negative
relationship between inflation rate and foreign direct investment. Asiedu (2002) mentioned
that a low inflation rate is taken as a sign of internal economic stability in the host country,
reflecting a lesser degree of uncertainty which encourage foreign direct investment.
Inflation is an important determinant of FDI inflows in Malaysia. It is supported by James
P. Walsh and Jiangyan (2010), who found that, the negative relationship of inflation rate,
when low, will give attractive benefits to attract additional FDI.

2. CONCLUSION
While there are many factors that affect Malaysias FDI inflows, the most significant
determinants are its market size, economic growth, trade openness, and inflation rate.

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