Pakistan, like other developing countries across the world faces the resource constraint and attracts foreign capital in the form of foreign direct investment (FDI). This shortage of financial resources is caused due to gap between saving and investment. A number of factors affect the inflow of foreign direct investment, including variations in exchange rate and inflation rate in a country. The present study is conducted to explore the link between FDI and exchange rate and inflation rate. For empirical analysis it utilized annual data set ranging from 1975 to 2015 and applied econometric methodology of Vector Error Correction Method (VECM). The checking of time series characteristics of all variables is followed by testing the existence of long run relationship and finally estimation of short run and long run elasticities of the model. Major findings confirmed the existence of long run relationship between FDI and exchange rate and inflation. Major policy recommendations include the control on inflation rate and exchange rate volatility is important instruments to attract FDI inflows in Pakistan and hence raising the overall economic development standards.
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