Abstract

This research examines the determinants of investment at the firm level in the context of Textile Sector in the economy of Pakistan, specifically how macroeconomic variables and firm-level factors affect investment. With a balanced panel data of 119 firms from 2009 to 2023, the study used both Fixed Effects and Generalized Method of Moments (GMM) estimations to analyze the influence of real interest rates, real effective exchange rate (REER), age, size, liquidity, profitability, and shareholders’ equity on capital accumulation. A major contribution of this study is a state dependent analysis to compare how investment acts at firm level when the economy goes through recessionary phase when GDP is below average as well as when GDP is moving above average to generate some business confidence that influences investment behavior. The findings reveal a significant negative relationship between real interest rates and firm investment measured as capital employed, which represents the total long-term capital invested in firms after adjusting for current liabilities, confirming that higher borrowing costs dampen long-term capital formation. This effect is notably stronger during periods of below-average GDP growth, indicating that monetary tightening severely constrains investment when economic conditions weaken. Conversely, during strong GDP growth, the sensitivity of investment to interest rates declines and often becomes statistically insignificant, suggesting that robust economic expansions can mitigate the impact of higher borrowing costs.