Causal relationship between economic growth and foreign direct investment, trade openness, gross capital formation and real effective exchange rate in Uganda

Abstract

This article examines the relationship between foreign direct investment (FDI), Trade openness (TO), Real effective exchange rate (REER), Gross capital formation (GCF) and economic growth in Uganda for the 1986 to 2023 period using the Autoregressive Distributed Lag (ARDL) approach and the Toda-Yamamoto (1995) method. The Toda-Yamamoto results show that there is unidirectional causality from Foreign Direct Investment (FDI) to Economic growth, real effective exchange rate (REER) and unidirectional causality from REER to FDI. There is no evidence of significant causality from Trade openness, REER, and GCF to economic growth. In the short run the previous values of TO, REER affected economic growth positively while FDI affected economic growth positively but previous values of FDI significantly affected economic growth negatively. In the log run FDI, GCF positively affected economic growth. From sustainability perspective, the lack of a significant causal effect from REER, TO and GCF to economic growth suggests that Uganda’s economic policy, which is based on private sector-led and TO led growth, has not significantly transformed the economy to bring about significant growth-enhancing effects. This study recommends that policymakers in Uganda should identify measures that enhance trade openness (exports and imports) competitiveness alongside investment promotion that could assure diversification of the country’s exports to international markets that could improve REER.