FDI, Financial Development, and CO₂ Emissions in SAARC Economies: Evidence from Cross-Sectionally Augmented ARDL Panel Estimation

Abstract

This study examines the long-run and short-run determinants of carbon dioxide (CO₂) emissions in six SAARC economies — Bangladesh, Pakistan, Bhutan, India, Nepal, and Sri Lanka — over the period 2000–2024. Employing a Cross-Sectionally Augmented Autoregressive Distributed Lag (CS-ARDL) framework to address the documented cross-sectional dependence across the panel, this paper investigates the roles of foreign direct investment (FDI) inflows, financial development (proxied by broad money supply), per capita income, internet penetration, renewable energy consumption, and urbanisation as drivers of environmental quality. The Pesaran (2004) Cross-Sectional Dependence (CD) test confirms the presence of strong cross-sectional dependence, justifying the use of second-generation panel unit root and cointegration tests. The Cross-Sectionally Augmented IPS (CIPS) panel unit root test establishes that all series are integrated of order one, I(1), and the Westerlund (2007) panel cointegration test confirms a stable long-run equilibrium. CS-ARDL Pooled Mean Group (PMG) estimates reveal that renewable energy is the dominant and statistically significant determinant of CO₂ abatement (coefficient: −1.230, p < 0.01), while evidence supporting the Environmental Kuznets Curve (EKC) hypothesis is country-heterogeneous. FDI exhibits a modest emission-reducing effect consistent with the Pollution Halo hypothesis, though it does not attain conventional significance at the panel level. These findings carry important implications for regional climate policy and the alignment of developmental finance with net-zero commitments under the Paris Agreement.