The role of political stability in the effects of foreign capital investments on financial development and capital markets

A country's financial development is directly related to foreign investment in that country. Investors contribute to the growth and development of developing countries, particularly those with insufficient savings, by making foreign capital investments. Political stability is another issue of interest to investors. Political stability offers investors the opportunity to invest in a more favorable environment, minimizing the impact of political fluctuations in a country. The primary objective of this research is to determine the role of political stability in the effects of foreign capital investments on financial development and capital markets. Using data from the 2002-2021 period for countries listed on the MSCI developing countries list, the study attempts to explain the relationship between political stability and foreign capital investments, financial development, and capital markets using various econometric analysis methods. Cointegration analyses reveal that the relationships between FDI and both SP and FG are cointegrated in the long run, and that the POL, JPR, HK, and DK variables are included in this cointegration relationship. Cointegration analyses indicate that foreign investment, capital markets, and financial development should be considered together. Causality tests by Emirmahmutoğlu and Köse (2011) were used to measure the causality relationship in the series. The findings indicate a causal relationship running from financial development to foreign direct investment, and the interaction between foreign direct investment and political stability demonstrates reciprocal causality with financial development. The interaction between regulatory quality and foreign direct investment also demonstrates reciprocal causality with financial development. The interaction between geopolitical risk factors and foreign direct investment also demonstrates reciprocal causality with financial development. Therefore, policymakers should take steps not only to strengthen financial infrastructure but also to ensure political and regulatory stability.