Foreign Direct Investment Response to Monetary Policy Tools Fluctuations in Tanzania

Abstract

Foreign Direct Investment (FDI) plays a vital role in driving economic growth, yet its responsiveness to monetary policy instruments remains underexplored in Tanzania. This study examines the relationship between FDI and monetary policy tools using annual time series data from 1960 to 2023, sourced from the World Bank and the Bank of Tanzania. Guided by the Interest Rate Parity theory, the study employs Autoregressive Distributed Lag (ARDL) and Vector Autoregressive (VAR) models, along with Granger causality tests, to capture both short-run dynamics and causal interactions. Based on 64 observations, the study reveals average values of 48.07% for income from the Treasury Account, 12.1% for the discount rate, and TZS 14,040.99 billion for reserves. Unit root tests confirm that most variables are integrated of order one, I(1). ARDL results show that previous FDI levels and the discount rate (β = 0.90, p = 0.0041) significantly predict current FDI inflows, while reserves and Treasury yields have statistically insignificant effects. Granger causality analysis indicates a bidirectional relationship between FDI and the discount rate, and a unidirectional link from FDI to reserves. Diagnostic tests confirm model reliability and stability, with no serial correlation or heteroskedasticity. The study recommends that monetary authorities adopt interest rate policies that stimulate borrowing and investment, fostering a more favorable environment for sustained economic growth.