Abstract

Foreign direct investment and foreign trade are vital factors in economic growth and development. The purpose of this study is to investigate the long run relationship and short-run dynamics between the two variables in Sri Lankan context. The study applies the ARDL co-integration and bound test for annual time series data covering the period from 1980 to 2016. The empirical test finds a significant positive relationship between FDI and foreign trade in the short run as well as in the long run. The bound test confirms the existence of co-integration relations among the variables. The error term of the ARDL ECM model is statistically significant with expected sign confirming convergence of short-run shocks into the long run equilibrium. All the diagnostic and stability tests confirm the validity of the selected model in policy formulating.