Does financial deepening attract foreign direct investment? Fresh evidence from panel threshold analysis

This study investigates the nexus between financial deepening (FD) and foreign direct investment (FDI) in the context of a heterogeneous panel of One Belt One Road partner countries, using a relatively new FD index proposed by the International Monetary Fund. The study also adds value to the literature by exploring the nonlinearity with a panel threshold model. The study finds that FD has a significant and positive impact on attracting foreign investments. However, panel threshold regression finds that countries with FD below a threshold of 0.1803 are less attractive to foreign investors. This finding implies that to maximize the benefits of FDI, economies in the region will have to deepen their financial sector above this threshold. Interestingly, the financial system of emerging markets and low-income countries in the sample significantly and positively affects FDI, but this relation disappears among advanced markets. Overall, the findings are robust to alternative estimators, addressing endogeneity, cross-sectional dependence, heteroscedasticity, and serial correlation.