Unravelling Capital Investment Horizons: The Mediating Effect of Exchange Rate Volatility on Macroeconomic-Sectoral Investment Nexus in Pakistan

Abstract

This study investigates the critical mediating role of exchange rate volatility in the relationship between key macroeconomic indicators and sectoral financial investments in Pakistan from 2014 to 2023. Employing a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) model to quantify exchange rate volatility and mediation analysis in R, we analyse its effect on investments in green finance, roads/dams, and metro projects. Our results reveal that exchange rate volatility is a significant transmission channel, mediating 70% of the effect of oil prices on investments but only 1% of the impact of Foreign Direct Investment (FDI), underscoring FDI's stabilizing role. Tax rates exert a strong direct negative influence, while stock market growth boosts investments but exacerbates volatility via speculative flows. Sectorally, green finance is highly sensitive to tax policy, roads/dams rely on FDI, and metro projects suffer from political reprioritization. The study contributes a dual-channel investment theory and offers policy recommendations, including oil-hedging mechanisms, renewable energy transitions, and sector-specific FDI facilitation, advocating for integrated macroeconomic-infrastructure planning in volatile emerging markets.