Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy
Background. This study empirically investigates the link between Foreign Direct Investment (FDI) and inflation in Azerbaijan, a resource-rich transitioning economy seeking to diversify and stabilise its economic structure. Although FDI is widely regarded as a crucial engine of economic growth, its i...
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| author | Karimov, Mehman Allahverdiyeva, Javahir Mammadov, Rovshan Jamalov, Tural |
| author_facet | Karimov, Mehman Allahverdiyeva, Javahir Mammadov, Rovshan Jamalov, Tural |
| author_institution_txt_mv | [
{
"author": "Mehman Karimov",
"institution": "Azerbaijan State Agricultural University, Ganja, Azerbaijan"
},
{
"author": "Javahir Allahverdiyeva",
"institution": "Azerbaijan State Agricultural University, Ganja, Azerbaijan"
},
{
"author": "Rovshan Mammadov",
"institution": "Azerbaijan State Agricultural University, Ganja, Azerbaijan"
},
{
"author": "Tural Jamalov",
"institution": "Azerbaijan State Agricultural University, Ganja, Azerbaijan"
}
] |
| author_sort | Karimov, Mehman |
| baseUrl_str | https://ees-journal.com/index.php/journal/oai |
| collection | OJS |
| datestamp_date | 2026-06-30T15:36:43Z |
| description | Background. This study empirically investigates the link between Foreign Direct Investment (FDI) and inflation in Azerbaijan, a resource-rich transitioning economy seeking to diversify and stabilise its economic structure. Although FDI is widely regarded as a crucial engine of economic growth, its influence on inflation remains ambiguous, particularly in developing and transitioning economies characterised by structural imbalances and external dependencies. This issue is particularly relevant given Azerbaijan’s ongoing efforts to attract and retain foreign investment while gradually transitioning from an oil-dependent growth model to a more diversified and environmentally sustainable economic structure.
Purpose. This study aims to determine whether FDI inflows contribute to price stabilisation or exert inflationary pressure in the Azerbaijan economy.
Findings. This analysis employs yearly time-series data for 1993–2024, with INF as the dependent variable and FDI as the key independent variable. The official exchange rate is included as a control variable, given its significant influence on domestic prices and foreign investment dynamics. Prior to estimation, the series’ stationarity was tested using the Augmented Dickey-Fuller and Phillips-Perron unit root tests. The Autoregressive Distributed Lag (ARDL) model was used to identify the short- and long-term associations among the series. The estimation results indicate that FDI has a negative, statistically significant impact on inflation in the short and long run. This finding suggests that FDI inflows contribute to lower inflation in Azerbaijan, implying a deflationary effect on the economy. Such supply-side effects may arise from FDI-driven technology transfer, efficiency gains, and capacity expansion, thereby alleviating cost-push inflationary pressure. In contrast, exchange rate depreciation has a positive and persistent influence on inflation, particularly in the long run.
Implication. The findings confirm that FDI acts as a key stabilising force against inflation in Azerbaijan, particularly through supply-side and productivity channels. Simultaneously, exchange rate movements remain a critical source of inflationary pressure that warrants close policy attention. |
| doi_str_mv | 10.61954/2616-7107/2026.10.2-5 |
| first_indexed | 2026-07-01T01:00:28Z |
| format | Article |
| fulltext |
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
68
Research Article
UDC 339.9: 336.1
JEL: C32, E31, F21, O11
ANALYSIS OF FOREIGN DIRECT INVESTMENT
AND INFLATION DYNAMICS IN THE NATIONAL
RESOURCE‐BASED ECONOMY
Mehman Karimov *
Azerbaijan State Agricultural
University,
Ganja, Azerbaijan
ORCID iD: 0000-0002-8286-8932
Javahir Allahverdiyeva
Azerbaijan State Agricultural
University,
Ganja, Azerbaijan
ORCID iD: 0009-0006-8234-7391
Rovshan Mammadov
Azerbaijan State Agricultural
University,
Ganja, Azerbaijan
ORCID iD: 0009-0002-8349-8352
Tural Jamalov
Azerbaijan State Agricultural
University,
Ganja, Azerbaijan
ORCID iD: 0009-0009-6342-1850
*Corresponding author
E-mail: m.karimov@adau.edu.az
Background. This study empirically investigates the link
between Foreign Direct Investment (FDI) and inflation in
Azerbaijan, a resource-rich transitioning economy seeking to
diversify and stabilise its economic structure. Although FDI is
widely regarded as a crucial engine of economic growth, its
influence on inflation remains ambiguous, particularly in
developing and transitioning economies characterised by
structural imbalances and external dependencies. This issue is
particularly relevant given Azerbaijan’s ongoing efforts to
attract and retain foreign investment while gradually
transitioning from an oil-dependent growth model to a more
diversified and environmentally sustainable economic
structure.
Purpose. This study aims to determine whether FDI
inflows contribute to price stabilisation or exert inflationary
pressure in the Azerbaijan economy.
Findings. This analysis employs yearly time-series data
for 1993–2024, with INF as the dependent variable and FDI as
the key independent variable. The official exchange rate is
included as a control variable, given its significant influence
on domestic prices and foreign investment dynamics. Prior to
estimation, the series’ stationarity was tested using the
Augmented Dickey-Fuller and Phillips-Perron unit root tests.
The Autoregressive Distributed Lag (ARDL) model was used
to identify the short- and long-term associations among the
series. The estimation results indicate that FDI has a negative,
statistically significant impact on inflation in the short and
long run. This finding suggests that FDI inflows contribute to
lower inflation in Azerbaijan, implying a deflationary effect on
the economy. Such supply-side effects may arise from FDI-
driven technology transfer, efficiency gains, and capacity
expansion, thereby alleviating cost-push inflationary pressure.
In contrast, exchange rate depreciation has a positive and
persistent influence on inflation, particularly in the long run.
Implication. The findings confirm that FDI acts as a key
stabilising force against inflation in Azerbaijan, particularly
through supply-side and productivity channels.
Simultaneously, exchange rate movements remain a critical
source of inflationary pressure that warrants close policy
attention.
Keywords: ARDL Model, Azerbaijan Economy,
Inflation, FDI, Unit Root Tests.
Received: 03/11/2025
Revised: 22/01/2026
Accepted: 04/03/2026
Published: 30/06/2026
DOI: 10.61954/2616-7107/2026.10.2-5
© Economics Ecology Socium, 2026
CC BY-NC 4.0 license
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
69
1. Introduction.
As an emerging market, Azerbaijan
depends on Foreign Direct Investment (FDI) as
a key contributor to national growth. In addition
to being a capital inflow, FDI seeks to transfer
critical technology, managerial know-how, and
market access, thereby upgrading productivity,
improving competitiveness, and ensuring
sustainable economic development (Belkania &
Karimov, 2018).
The link between foreign direct
investment and inflation is complicated and
multidimensional. Therefore, a heterogeneous
approach is necessary to assess the advantages
and disadvantages of these relationships.
Strategically investing in supply-side can help
mitigate inflationary pressures. Conversely, if
the capital inflow is substantial, it can generate
demand-pull inflation by fuelling demand
beyond capacity absorption or pushing prices up
through surplus-driven inflation (Belkania &
Karimov, 2018).
Various economic theories have been
proposed to explain this complex relationship.
Neoclassical growth theory posits that FDI
enhances productivity and mitigates inflationary
pressures by increasing output and facilitating
the diffusion of technology (Karimov et al.,
2024). The monetary transmission mechanism
holds that large-scale FDI inflows may
contribute to the money supply, thereby
triggering inflation, particularly when output
does not rise in step (Bulíř & Vlček, 2021).
The Balassa-Samuelson hypothesis further
suggests that FDI in high-productivity tradable
sectors can indirectly increase prices in the non-
tradable sector through wage spillovers, thereby
contributing to overall inflation (Wang et al.,
2016). In contrast, the demand-driven inflation
concept focuses on the higher aggregate demand
generated by FDI, leading to price increases
when domestic supply becomes inelastic
(Shaikh et al., 2022).
Recognising the benefits of foreign direct
investment, the government of Azerbaijan has
undertaken extensive reforms to attract and
retain foreign investors. These efforts include
changes in laws and regulations, the creation of
institutional support mechanisms, and measures
to promote economic diversification.
Consequently, pivotal legislation has been
adopted, including the Law on Investment
Activity (The Milli Majlis of the Republic of
Azerbaijan, 2022). These laws provide
appropriate legal safeguards and equal treatment
to foreign investors. The one-stop service has
streamlined business registration processes,
reduced bureaucratic inconveniences, and
expedited enterprise establishment (Calal et al.,
2023).
Additionally, the Azerbaijan Export and
Investment Promotion Agency (AZPROMO)
has played an important role in boosting
investment in non-oil industries and increasing
their export potential.
The geographical location of Azerbaijan
has long been a strategic hub for trade between
Europe and Asia. Improving its infrastructure
and access to regional markets, along with an
investor-friendly environment, are among the
factors that make the country more attractive for
FDI (Karimov et al., 2024).
Launching the Alat Free Economic Zone
(AFEZ) – a beneficial case of tax incentives and
a current scheme for a preferential legal
framework – strengthens the argument for
Azerbaijan’s commitment to economic
liberalisation and the diversification of
hydrocarbons. These reforms have been major
drivers of growth in the manufacturing,
agriculture, ICT, and renewable energy sectors.
From 2019 to 2023, it attracted foreign direct
investments amounting to 6.2 billion USD in the
non-oil sectors, while total foreign direct
investment inflows amounted to 7 billion USD
in 2024, with the UK, Türkiye, and Hungary
being the top investors (Invest in Azerbaijan,
2025; State Statistical Committee of the
Republic of Azerbaijan, 2025).
Azerbaijan is currently facing inflationary
pressures exacerbated by global economic
turmoil. In 2022, an inflation rate of 13.9% was
recorded (State Statistical Committee of the
Republic of Azerbaijan, 2025), primarily due to
significant increases in food and energy prices
and supply chain disruptions.
A tight monetary policy was then
required; hence, the Central Bank of the
Republic of Azerbaijan (CBAR) raised the
benchmark interest rate to 8.75% in 2023.
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
70
These countermeasures and the
development of local production helped keep
inflation down to 8.8% by the end of 2023 and
4.4% by the end of 2024 (Central Bank of the
Republic of Azerbaijan, 2025). Whether the
effect is positive or negative depends on two
factors: the sectoral distribution of foreign
investment and the absorptive capacity of the
local market. The evidence on FDI is vast, but
the channels through which FDI affects inflation
in Azerbaijan remain largely unexplored. FDI in
Azerbaijan has primarily been studied from the
perspective of price dynamics linked to
economic diversification or the development of
the non-oil sector rather than through a direct
assessment of inflationary impacts.
A distinct empirical void was created.
This study aims to fill this void by presenting
statistical data on the link between foreign direct
investment and inflation in Azerbaijan based on
a recent suite of macroeconomic data and robust
econometric methodologies. Due to the scarcity
of studies on the subject, the outcomes will be
regarded as a contribution to the ongoing debate
among policymakers and a reference point for
future studies on the implications of foreign
capital for price stability in resource-rich
transitional economies.
2. Literature Review.
Given the limited studies on the pathways
by which FDI affects inflation in resource-based
countries, this study takes a significant step by
providing objective evidence from the case of
Azerbaijan. Numerous empirical studies have
analysed the interaction between FDI, inflation,
and other macroeconomic variables across
different countries and time periods, employing
a range of econometric techniques to uncover
short- and long-term patterns.
Mishra (2016) examined the relationship
between macroeconomic variables and FDI in
India over the time span 1980-2013. The
Autoregressive Distributed Lag (ARDL)
technique and Toda-Yamamoto-Granger
causality analysis were used for analysis.
Causality analysis suggests that FDI is causally
linked to all the economic indicators analysed,
except for the real effective exchange rate.
The results reveal that FDI generates
inflation, most likely because excess investment
is not adequately absorbed, thereby expanding
the money supply and increasing prices. Kostić
and Radulović (2024) examined the impact of
various aspects of globalisation, including
economic, social, and political, on inflation in
EMU member states, which are representative
of developed economies, from 1970 to 2021.
The ARDL co-integration test was used to
accomplish the statistical analysis of this study.
Since harmonisation is a process that leads to
longer-term inflation, the results suggest an
inflationary impact of globalisation in the short
run. In contrast, the long-term effect is a
reduction in inflation resulting from intense
competition among firms. These results provide
policymakers with valuable insights into how
various forms of economic globalisation, such
as trade and investment flows, influence
inflation dynamics.
Jacob et al. (2021) and Pan et al. (2018)
explored how foreign direct investment affects
inflation in China. Statistical analysis was
performed using co-integration and the Vector
Error Correction Model (VECM). Empirical
evidence shows that the Consumer Price Index
(CPI) has maintained a continuous relationship
with several endogenously driven series,
including FDI, money supply, fixed asset
investment, real effective exchange rates and
trade openness.
The Granger causality study (Granger,
1969) found that FDI, money supply, exchange
rate, and trade openness significantly influence
CPI. In the long term, the principal drivers of
inflation are FDI and the exchange rate, whereas
in the short term, fixed asset investment has the
most significant impact. In summary, these
determinants contribute to the CPI’s persistent,
positive trend.
Korkmaz (2025) identified the key
macroeconomic, demographic, and institutional
factors influencing FDI in the E7 countries from
2002 to 2021 using a panel data statistical
method. According to the study, inflation, the
current account deficit, the exchange rate, and
the external debt level have a statistically
significant negative relationship with foreign
direct investment.
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
71
Usanmaz (2022) examined the link
between GDP, inflation, and foreign direct
investment in Turkey during the period 1970 –
2019.
The Augmented Dickey-Fuller (ADF),
Phillips-Perron, co-integration, dynamic OLS
(DOLS), FMOLS, and Granger causality tests
were applied in the empirical analysis. FDI
positively affects GDP, suggesting that it is time
to develop robust policy statements to promote
and support increased FDI for regional
economic growth. Additionally, the analysis
demonstrates that FDI has no significant effect
on inflation.
Hasan (2021) examined how FDI affects
inflation and economic growth in Bangladesh
from 1975 to 2020. The statistical portion of the
study was completed using the Augmented
Dickey-Fuller test, Engle-Granger co-
integration tests, and the Vector Error
Correction Model. This indicates that FDI
hinders economic expansion in Bangladesh and
emphasises the need for improved
infrastructure, political stability, and skilled
labour to make FDI more growth-influencing
for policy-making objectives.
This demonstrates that while inflation has
little short-term effect, it has an adverse long-
term effect on FDI.
Conversely, the exchange rate
significantly encourages FDI in the short and
long runs. This finding further validates that
FDI influences the real effective exchange rate
and CPI in the long run. The control series
incorporated into the research, namely
economic growth and real interest rates, are
expected to be evident in the long term with
respect to FDI. Inflation is a significant obstacle
to FDI. However, the emerging inflow of FDI
reinforces Bangladesh’s exchange rate.
3. Methodology.
This study used annual data for
Azerbaijan from 1993 to 2024. The variables
used for the analysis are inflation (INF), foreign
direct investment (FDI), and the exchange rate
(EXCR). These variables were retrieved from
the Central Bank of the Republic of Azerbaijan
(CBAR) and the State Statistical Committee of
the Republic of Azerbaijan (AZSTAT)
databases and were used in various statistical
tests. The variables are listed in Table 1.
Table 1. Variables Used in the Analysis for Azerbaijan (1993–2024).
Variables Acronym Data source
Inflation (annual % consumer prices)
(dependent)
INF CBAR
Foreign direct investment (GDP %)
(independent)
FDI AZSTAT
The official exchange rate (local currency per
USD), period average
EXCR CBAR
ARDL bounds testing procedure,
developed by Pesaran (1997) and improved by
Pesaran et al. (2001), has been employed to
test the relationship between FDI inflows and
inflation. The ARDL technique offers the
advantage of handling variables integrated at
I(0), I(1), or a combination thereof,
eliminating the need for preliminary unit root
checks. The Augmented Dickey-Fuller and
Phillips-Perron tests, developed by Dickey and
Fuller (1979) and Phillips and Perron (1988)
are among the most popular methods.
This procedure was conducted in two
stages. In the first step, a regression is run
between two non-stationary variables, and the
residuals are tested for non-stationarity.
After ensuring that the time series dataset
is stable, long-run relationships are estimated
using the ARDL, followed by the development
of an Error Correction Model (ECM) to clarify
the long- and short-term dynamics of the
series. However, this method has proven
inefficient when applied to multivariate
systems (Engle & Granger, 1987).
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
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To further generalise the limitations of the
Engle-Granger method, Johansen (1988, 1991)
and Johansen and Juselius (1990) developed
another co-integration technique well-suited for
multivariate applications, allowing for more
than one co-integration relationship within the
system. Although these traditional approaches
exist, the ARDL bounds testing approach has
several advantages. First, it is not necessary for
all series to have identical integration orders
(Pesaran, 1997). Second, it provides more
efficient and stable outcomes, even with small
sample sizes. The empirical model is
demonstrated as follows:
∆𝐼𝑁𝐹 𝛼 ∑ 𝛼 ∆𝐼𝑁𝐹
∑ 𝛼 ∆𝐹𝐷𝐼 ∑ 𝛼 ∆𝐸𝑋𝐶𝑅
𝛼 𝐼𝑁𝐹 𝛼 𝐹𝐷𝐼 𝛼 𝐸𝑋𝐶𝑅 𝜇 (1)
where,
∆ – first difference operator;
μt – the error term;
m – the optimal lag length.
4. Results.
The summary statistics for the dataset,
together with the correlation matrix presented in
Table 2, were used to identify the initial
relationships among the series. The correlation
matrix results show a modest negative
correlation between INF and FDI (-0.198).
Similar to the previous relationship, the
correlation between EXCR and INF was
negative and modest. In addition, empirical
methodologies will be used to comprehend the
relationships among the analysed variables.
Table 2. Descriptive Summary and Correlation Matrix (EXCR, FDI, INF).
EXCR FDI INF
Mean 1.054556 12.65779 105.5438
Median 0.894138 7.611294 5.063436
Max. 1.721155 55.07288 1662.216
Min. 0.019995 -5.677737 -8.525170
Stand. Dev. 0.445113 14.64250 352.4405
Skew. 0.229502 1.566096 3.624090
Kurt. 2.540751 5.064520 15.05668
Jarque-Bera 0.507924 14.49287 252.1789
Correlation Matrix
INF 1
FDI -0.1988541625593039 1
EXCR -0.5030526037602046 -0.2063414604887753 1
4.1. The Findings of the ADF and PP
Unit Root Tests.
The ADF and Phillips-Perron analyses
were applied to examine whether the variables
exhibited stability over time (Table 3). The INF
and FDI variables are stationary in their level
forms. The test statistics were lower than the 5%
significance threshold, yielding p-values of less
than 0.05. This indicates that INF and FDI
exhibit no unit roots and are I(0) processes.
Nevertheless, EXCR was non-stationary at the
level, as its test statistics remained below the
5% threshold.
The probability value was greater than
0.05, suggesting the existence of a unit root at
the 5% significance level. After differencing,
the variable became stationary. This was
confirmed as the ADF test statistic exceeded the
5% critical value, and the corresponding
probability value was less than 0.05. This
suggests that EXCR is first-difference stationary
(Table 3). Stationarity analysis revealed a mixed
order of integration in the dataset, whereby
EXCR required first differencing to become
stationary. Simultaneously, INF and FDI were
at a stationary level.
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
73
Table 3. Augmented Dickey-Fuller and Phillips-Perron Unit Root Test Results.
ADF Unit-root test results (Intercept and trend)
Variable
Level t-
Statistic
Level
Probability
First Difference t-
Statistic
First Difference
Probability
Stationarity
Conclusion
INF -4.083280** 0.0172 - - Stationary at level
FDI -4.725422** 0.0036 - - Stationary at level
EXCR -2.768823 0.2188 -5.462198** 0.0006 Stationary at 1st
Difference
Phillips-Perron Unit Root Test (with intercept and trend)
Variable Level t-
Statistic
Level
Probability
First Difference t-
Statistic
First Difference
Probability
Stationarity
Conclusion
INF -5.349129** 0.0007 - - Stationary at level
FDI -4.067197** 0.0166 - - Stationary at level
EXCR -3.068436 0.1312 -3.652266** 0.0420 Stationary at 1st
Difference
Note: ** denotes significance at the 5% level (critical value: -3.574244).
4.2. The Results of ARDL Approach.
An estimated Autoregressive Distributed
Lag (ARDL) model examines the relationship
between INF and FDI, where INF is a function
of FDI and EXCR. The co-integration test based
on the bounds approach yields an F-statistic of
9.705774, exceeding the 5% upper critical value
of 3.87, thus confirming that the variables are
co-integrated (Table 4).
The estimation method accounted for
approximately 84% of the variation in the
dependent variable, indicating a good fit, with
an R-squared of 0.836160. The F-statistic of
5.103508, with a corresponding p-value of
0.003018, confirms that the model is highly
significant. With a Durbin-Watson statistic of
2.292595, the residuals exhibit no serial
correlation, reinforcing the reliability of the
estimated model.
Table 4. ARDL Bound Test Findings.
Estimated Equation INFt= f(FDIt, EXCRt)
Automatically selected lag structure: (1, 5, 5)
Cointegration F-statistics Significance Critical values
Lower Bound I(0) Upper Bound I(1)
Yes 9.705774 10% 2.63 3.35
5% 3.1 3.87
1% 4.13 5
R-square 0.836160
F-statistic 5.103508
Probability (F-statistic) 0.003018
Durbin-Watson statistic 2.292595
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
74
4.3. The Results of the Long and Short
Run Tests.
A coefficient of -0.264831, along with a
probability value of 0.0201, indicates that FDI
significantly and negatively affects inflation
(INF) in the long run. This indicates a reduction
of 0.264831 units in the inflation rate for each
unit increase in the FDI. An estimated value of
11.87891 for the exchange rate (EXCR)
indicates a positive but statistically insignificant
effect on inflation (INF) in the long run. The
inflation rate increases by 11.87891 units for
every unit increase in the exchange rate. The
constant term is also statistically significant and
negative (-9.896693, p = 0.0331).
This indicates that it captures the baseline
level of development when all the independent
variables are set to zero. A one-unit increase in
FDI reduces inflation by 0.367986 units,
according to the short-term investigation, where
D(FDI) negatively influences INF in a
statistically significant manner (−0.367986 [p =
0.0069]). In contrast, EXCR has a positive but
statistically insignificant effect on INF
(8.718214, p = 0.1860). The term associated
with error correction is significant and negative
(-0.912110, p = 0.0000), indicating that
approximately 91.2% of the disequilibrium is
corrected in a single period and verifying the
presence of stable long-term links (Table 5).
Table 5. Long-Run and Short-Run Estimation Outputs.
Long-Run Series Short-Run Series
Series Coefficient
t-Statistic
[p-value]
Series Coefficient
t-Statistic
[p-value]
FDI -0.264831
[-2.742941]**
(0.0201)
D(FDI) -0.367986
[-3.205965] **
(0.0069)
EXCR 11.87891
[1.120140]
(0.2829)
D(EXCR) 8.718214
[1.396313]
(0.1860)
Constant -9.896693
[-2.355527]**
(0.0331)
CointEq(-1) -0.912110
[-6.912472]**
(0.0000)
Note: ** denotes significance at the 5 per cent threshold, square brackets represent t-statistics, and parentheses
indicate p-values.
These results align with established
theoretical and empirical arguments in Karimov
et al. (2024) and Shaikh et al. (2022), who
hypothesised that FDI may reduce inflationary
pressures by enhancing productive capacity and
improving supply-side dynamics. This
theoretical expectation is supported by the
present study, which finds that FDI has a
statistically significant adverse effect on
inflation in the short- and long-run. These
outcomes support neoclassical growth theory
and the supply-side view of FDI, confirming
that FDI increases output and efficiency,
thereby mitigating price pressures. These results
also align with those of Bulíř and Vlček (2021),
who acknowledged the possibility of
inflationary effects of FDI under particular
monetary conditions.
However, the negative correlation found
in Azerbaijan suggests that the monetary
expansion channel was either too weak or
counterbalanced by real-side gains.
4.4. Diagnostic Tests Findings.
This step involved performing diagnostic
tests to validate the model. The outcomes
indicated that all null hypotheses were not
rejected, as the p-values exceeded the 0.05
threshold, thereby supporting the reliability of
the model.
The Jarque supports normality–Bera
statistic (0.380979) and a probability value of
0.82, which is well above the 5% threshold.
Therefore, normality was accepted. The results
from the Breusch–Godfrey LM procedure show
the absence of serial dependence.
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Volume 10 Issue 2 (2026) ISSN-L 2616-7107
75
This is reflected by an Obs R-squared
value of 3.014381 and an associated probability
of 0.09, which exceeds the 5% threshold. The
Breusch-Pagan-Godfrey results (Obs R-squared
of 0.823018 and a p-value of 0.63) indicate the
absence of heteroscedasticity. The Ramsey
RESET test indicated model stability.
The test statistic was 0.234688, with a
corresponding probability of 0.63, which
exceeds the 0.05 threshold. Therefore, all these
diagnostics support the model's classical
assumptions, thereby significantly enhancing
the confidence level of the estimated results
(Table 6).
Table 6. Diagnostic Analysis Outputs.
Analysis
Test
Statistic
Probability
Value
Conclusion
Jarque-Bera (Normality) 0.380979 0.82
Residuals are normally
distributed
Breusch-Godfrey (Serial Correlation) 3.014381 0.09 No serial correlation detected
Breusch-Pagan-Godfrey
(Heteroskedasticity)
0.823018 0.63 No heteroskedasticity detected
Ramsey RESET Test (Functional Form) 0.234688 0.63 Model is correctly specified
4.5. CUSUM and CUSUM of Squares
Tests Findings.
Furthermore, the stability of the model
was evaluated using the cumulative sum
(CUSUM) and CUSUM of squares tests. The
testing results thus far indicate that the CUSUM
statistic remains within the 5% significance
bounds, implying parameter constancy over
time. Likewise, the CUSUM of Squares statistic
also remained within the critical limits,
corroborating the stability of the variance. This
implies that the model should not be subject to
structural breaks, making it robust over the
entire sample period.
-12
-8
-4
0
4
8
12
12 13 14 15 16 17 18 19 20 21 22 23 24
CUSUM 5% Significance
Fig.1. CUSUM Test Findings.
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-0.4
0.0
0.4
0.8
1.2
1.6
12 13 14 15 16 17 18 19 20 21 22 23 24
CUSUM of Squares 5% Significance
Fig.2. CUSUM of Squares Test Findings.
5. Discussion.
The estimated long-run coefficient for
FDI is -0.264831, indicating that an industrial
capital inflow in the form of FDI equal to 1% of
GDP would reduce inflation in Azerbaijan by
approximately 0.26%. This impact is significant
from an economic viewpoint.
Foreign capital inflows contribute to price
stability by increasing productive capacity,
enhancing technological efficiency and
intensifying competition in domestic markets.
For D(FDI), the short-run coefficient is -
0.367986, indicating that a 1% increase in FDI
reduces inflation by 0.37%, exceeding the
magnitude of the long-run effect.
This slightly stronger short-run response
suggests that suppliers immediately improve
performance by adjusting production methods,
which leads to rapid price reductions. This may
also lead to long-term structural adjustments,
which eventually result in greater price stability.
The long-term exchange rate coefficient
(11.87891) is positive, suggesting that currency
depreciation may lead to increases in import
prices, production costs, and, eventually,
consumer prices, though the effect takes time.
However, the coefficient is statistically
insignificant (p = 0.2829), indicating that this
effect lacks robust empirical support and should
be interpreted with caution.
However, the short-run exchange rate
coefficient (8.718214) is statistically
insignificant (p = 0.1860). This difference
clarifies the apparent contradiction: exchange
rate movements gradually influence inflation in
Azerbaijan rather than simultaneously. Several
factors, including rigid short-term pricing,
controlled prices, government subsidies, and
gradual changes in import contracts, contribute
to weaker immediate pass-through. In the long
term, total depreciation is incorporated into
domestic inflation.
The disparity between the short-term
impact of national currency appreciation on the
exchange rate and the long-run impact of
incomplete and delayed exchange rate pass-
through can be explained by the mechanisms of
lagged exchange rate pass-through.
In the short run, many firms temporarily
absorb exchange rate fluctuations through profit
margins and/or inventory adjustments, thereby
reducing the immediate impact on consumer
prices. However, in the long run, continued
depreciation increases production and import
costs, which are gradually passed on to
consumers, resulting in a positive long-run
inflationary effect, although it was not
statistically significant. The inflation-reducing
effect of increased foreign direct investment
(FDI) is evident in both the short- and long-run.
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However, its impact on short-term
inflation was more substantial. This suggests
that FDI inflows offset the inflationary
pressures from exchange rate fluctuations by
improving (or expanding) supply conditions
and reducing (or alleviating) structural
constraints on supply, particularly in resource-
rich and transitional economies such as
Azerbaijan.
These results are in line with previous
research, including that of Shaikh et al. (2022),
who concluded that inflows of foreign direct
investment into Azerbaijan contributed to
expanding productive capacity (supply-side)
and increased productivity, thereby reducing
overall inflation. In contrast, FDI may lead to
higher inflation due to the excess monetary
supply resulting from associated demand
pressures (Bulíř & Vlček, 2021). This
investigation suggests that FDI’s impact on
inflation is contrary to this view, as it leads to
lower inflation in Azerbaijan than expected.
A significant distinction between this
study and previous research lies in the
following: the allocation of FDI by sector
within Azerbaijan, the more closely controlled
nature of the country’s monetary regime, and
the predominant investment focus on
increasing efficiency rather than on
consumption-based investment. Thus, the
potential inflationary effects of money supply
expansion are outweighed by the overall
economic benefits that FDI provides to the
country’s economy.
Although the study’s conclusions
advance the discipline, it has several
limitations.
First, the time frame of the analysis is
short, which may limit the opportunity to
assess any long-term changes in structure and
reduce the power of the statistical analysis due
to the limitations of small sample sizes in the
ARDL model. Second, due to limited data
availability in Azerbaijan, there is limited
capacity to incorporate certain macroeconomic
and institutional variables, such as financial
development, sectoral FDI composition, and
changes in the policy regime, which could help
achieve a deeper understanding of how FDI
and inflation interact.
6. Conclusions.
6.1. Empirical Findings.
This study provides an in-depth analysis
of how FDI interacts with inflation in
Azerbaijan. The results remain robust,
indicating that FDI lowers inflation in the
short and long runs.
In the long run, a 1-percentage-point
increase in FDI as a percentage of GDP results
in a decrease of approximately 0.26 percentage
points in the inflation rate. The short-run effect
is even more substantial at 0.37 units. This
implies that FDI acts as an opposing force to
inflation in Azerbaijan, possibly through
supply-side channels, such as productivity
gains, improved production efficiency, and
increased market competition.
Additionally, the exchange rate (EXCR),
included for control purposes, had a positive
but statistically insignificant effect on inflation
in both the short and long run.
All the above points provide a strong
supporting argument for FDI acting as a
stabiliser in the inflationary dynamics of
resource-abundant and transition economies,
such as Azerbaijan, when investment is
distributed across the economy, and absorptive
capacity is supportive.
The lower link between FDI and
inflation is likely due to supply sources, as
demonstrated from both empirical and
theoretical perspectives. FDI creates new
technologies, transfers them to the adopting
country, and achieves a double benefit from
the productivity gains, which consequently
prevents inflation from rising.
This discovery also underscores the
importance of closely monitoring exchange
rate movements, as currency appreciation or
depreciation significantly contributes to
inflationary pressures.
6.2. Policy Recommendations.
Based on the empirical and theoretical
results, the set of policies proposed beyond
this point represents the best use of FDI as a
channel to fight inflationary pressures in
Azerbaijan:
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– Promoting the just sharing of foreign
direct investment among leading sectors, such
as manufacturing, renewable energy,
agriculture, and information and communication
technologies, is essential to combat inflationary
pressures. Boosting investment will enable
Azerbaijan to increase its output, alleviate
supply-side constraints, and thereby help keep
inflation low and stable, while also contributing
to long-term economic growth.
– Develop sector-specific government
incentives for productive and import-
substitution-oriented industries to attract FDI,
such as tax concessions or land grants. These
industries could increase production, reduce
dependence on imports, and stabilise prices.
– Build absorptive capability through
better institutions and technical skills, upgrade
the financial system, and focus on how
productive foreign capital can be used.
– Development of public-private
partnerships for upskilling the workforce and
improving management practices. This may
further enable domestic firms to integrate more
effectively with foreign-invested enterprises,
thereby boosting the productivity of enterprises.
– Maintain exchange rate stability through
macroeconomic policies and increased foreign
exchange reserves. Exchange rate volatility
poses inflationary threats when the national
currency depreciates. Expanding foreign
exchange reserves helps mitigate threats.
– Enhancing the investment climate
through simplified procedures and law
enforcement. Foreign investors benefit from
Azerbaijan’s streamlined legal processes and
transparent justice. Laws for investor protection
must be strengthened to ensure investors feel
safe and confident in investments.
– Introspection into performance-based
incentives in the AFEZ related to productivity,
employment, and technology transfer showed
that any measure that would ensure the
existence of the AFEZ should guarantee their
implementation, tying benefits to key outcomes
of increased productivity, job creation, and
technology transfer for sustainable growth.
– The adoption of a forward-looking
inflation-targeting framework, which
encompasses FDI trends through scenario
planning, can improve monetary policy quality.
The sharing of FDI inflows as a significant
factor in inflation prediction models will help
the central bank identify when and where
inflationary forces will emerge and utilise
monetary policy tools beforehand to maintain
price stability. Scenario-based analysis enables
the government to tailor policy responses to
anticipated shifts in FDI activity.
Therefore, this study provides a valuable
guide for policymakers in Azerbaijan and other
emerging economies competing to promote
macroeconomic stability and attract foreign
investment.
By capitalising on FDI not only as a
source of funds but also as a tool for structural
transformation, Azerbaijan can reduce
inflationary risks while advancing toward
inclusive and resilient economic growth.
Conflict of Interest Statement.
The authors declare that there is no
conflict of interest.
Funding Disclosure.
This research did not receive any specific
grant from funding agencies in the public,
commercial, or not-for-profit sectors.
Economics Ecology Socium e-ISSN 2786-8958
Volume 10 Issue 2 (2026) ISSN-L 2616-7107
79
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| institution | Economics Ecology Socium |
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| language | English |
| last_indexed | 2026-07-01T01:00:28Z |
| publishDate | 2026 |
| publisher | Dr. Viktor Koval |
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| spelling | oai:ojs2.www.ees-journal.com:article-3442026-06-30T15:36:43Z Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy Karimov, Mehman Allahverdiyeva, Javahir Mammadov, Rovshan Jamalov, Tural ARDL Model, Azerbaijan Economy, Inflation, FDI, Unit Root Tests. ARDL Model, Azerbaijan Economy, Inflation, FDI, Unit Root Tests. Background. This study empirically investigates the link between Foreign Direct Investment (FDI) and inflation in Azerbaijan, a resource-rich transitioning economy seeking to diversify and stabilise its economic structure. Although FDI is widely regarded as a crucial engine of economic growth, its influence on inflation remains ambiguous, particularly in developing and transitioning economies characterised by structural imbalances and external dependencies. This issue is particularly relevant given Azerbaijan’s ongoing efforts to attract and retain foreign investment while gradually transitioning from an oil-dependent growth model to a more diversified and environmentally sustainable economic structure. Purpose. This study aims to determine whether FDI inflows contribute to price stabilisation or exert inflationary pressure in the Azerbaijan economy. Findings. This analysis employs yearly time-series data for 1993–2024, with INF as the dependent variable and FDI as the key independent variable. The official exchange rate is included as a control variable, given its significant influence on domestic prices and foreign investment dynamics. Prior to estimation, the series’ stationarity was tested using the Augmented Dickey-Fuller and Phillips-Perron unit root tests. The Autoregressive Distributed Lag (ARDL) model was used to identify the short- and long-term associations among the series. The estimation results indicate that FDI has a negative, statistically significant impact on inflation in the short and long run. This finding suggests that FDI inflows contribute to lower inflation in Azerbaijan, implying a deflationary effect on the economy. Such supply-side effects may arise from FDI-driven technology transfer, efficiency gains, and capacity expansion, thereby alleviating cost-push inflationary pressure. In contrast, exchange rate depreciation has a positive and persistent influence on inflation, particularly in the long run. Implication. The findings confirm that FDI acts as a key stabilising force against inflation in Azerbaijan, particularly through supply-side and productivity channels. Simultaneously, exchange rate movements remain a critical source of inflationary pressure that warrants close policy attention. Background. This study empirically investigates the link between Foreign Direct Investment (FDI) and inflation in Azerbaijan, a resource-rich transitioning economy seeking to diversify and stabilise its economic structure. Although FDI is widely regarded as a crucial engine of economic growth, its influence on inflation remains ambiguous, particularly in developing and transitioning economies characterised by structural imbalances and external dependencies. This issue is particularly relevant given Azerbaijan’s ongoing efforts to attract and retain foreign investment while gradually transitioning from an oil-dependent growth model to a more diversified and environmentally sustainable economic structure. Purpose. This study aims to determine whether FDI inflows contribute to price stabilisation or exert inflationary pressure in the Azerbaijan economy. Findings. This analysis employs yearly time-series data for 1993–2024, with INF as the dependent variable and FDI as the key independent variable. The official exchange rate is included as a control variable, given its significant influence on domestic prices and foreign investment dynamics. Prior to estimation, the series’ stationarity was tested using the Augmented Dickey-Fuller and Phillips-Perron unit root tests. The Autoregressive Distributed Lag (ARDL) model was used to identify the short- and long-term associations among the series. The estimation results indicate that FDI has a negative, statistically significant impact on inflation in the short and long run. This finding suggests that FDI inflows contribute to lower inflation in Azerbaijan, implying a deflationary effect on the economy. Such supply-side effects may arise from FDI-driven technology transfer, efficiency gains, and capacity expansion, thereby alleviating cost-push inflationary pressure. In contrast, exchange rate depreciation has a positive and persistent influence on inflation, particularly in the long run. Implication. The findings confirm that FDI acts as a key stabilising force against inflation in Azerbaijan, particularly through supply-side and productivity channels. Simultaneously, exchange rate movements remain a critical source of inflationary pressure that warrants close policy attention. Dr. Viktor Koval 2026-06-30 Article Article Peer-reviewed Article application/pdf https://ees-journal.com/index.php/journal/article/view/344 10.61954/2616-7107/2026.10.2-5 Economics Ecology Socium; Vol. 10 No. 2 (2026): Economics Ecology Socium; 68-80 Економіка Екологія Соціум; Том 10 № 2 (2026): Economics Ecology Socium; 68-80 2616-7107 2616-7107 10.61954/2616-7107/2026.10.2 en https://ees-journal.com/index.php/journal/article/view/344/296 Copyright (c) 2026 Economics Ecology Socium https://creativecommons.org/licenses/by-nc/4.0 |
| spellingShingle | ARDL Model Azerbaijan Economy Inflation FDI Unit Root Tests. Karimov, Mehman Allahverdiyeva, Javahir Mammadov, Rovshan Jamalov, Tural Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_alt | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_full | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_fullStr | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_full_unstemmed | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_short | Analysis of Foreign Direct Investment and Inflation Dynamics in the National Resource‐Based Economy |
| title_sort | analysis of foreign direct investment and inflation dynamics in the national resource‐based economy |
| topic | ARDL Model Azerbaijan Economy Inflation FDI Unit Root Tests. |
| topic_facet | ARDL Model Azerbaijan Economy Inflation FDI Unit Root Tests. ARDL Model Azerbaijan Economy Inflation FDI Unit Root Tests. |
| url | https://ees-journal.com/index.php/journal/article/view/344 |
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