The Nexus between Foreign Direct Investment and Financial Stability in Ethiopia
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Date
2025-09
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Addis Ababa University
Abstract
This study investigates the nexus between Foreign Direct Investment and financial stability in Ethiopia using annual time series data from 2004 to 2023. A quantitative research design employed Ordinary Least Squares (OLS) regression, supported by diagnostic tests, to analyze the relationship between FDI inflows and financial stability. Key macroeconomic control variables included economic growth, government expenditure, net capital formation growth, foreign exchange reserves, and unemployment. Findings indicate that FDI had no statistically significant direct effect on financial stability. However, strong positive correlations were observed between government expenditure (r = 0.9177) and economic growth (r = 0.8976) with financial stability. Government expenditure significantly enhanced financial stability (β = 0.9949, p = 0.017). In contrast, net capital formation growth and foreign exchange reserves negatively affected stability, with coefficients of (β = -0.5158, p = 0.018) and (β = -1.2850, p = 0.004), respectively. The regression model explained 66.15% of the variance in financial stability (R² = 0.6615), with diagnostic tests confirming robustness. In conclusion, while FDI alone did not directly drive financial stability. The study highlights the critical role of government expenditure management and the need for strategic targeting of FDI to enhance financial stability in Ethiopia.
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Keywords
Foreign Direct Investment, Financial Stability, Ethiopia, Z-Score, Economic Growth, Government Expenditure, Macroeconomic Determinants, Regression Analysis.