Working Paper 254 - Exchange Rate Policies and FDI Flow in WAMZ

Based on the IMF de facto classification of countries’ exchange arrangements, this study examines the effect of exchange rate policies and inflationary expectation on foreign direct investment flow to the West African Monetary Zone (WAMZ). The Study employed the Arellano Panel Correction for Serial Correlation and Heteroscedaticity option of the Within Estimator for five of the WAMZ countries selected based on data availability for the period 1980-2014. Results showed that exchange rate uncertainty hampered FDI flow while inflation expectation had an insignificant effect on FDI flow to WAMZ. The fixed exchange rate policy regime was found to hamper FDI flow in the zone while intermediate policy regime had a significantly positive effect in facilitating FDI flow with periods of current account imbalances and changes in foreign exchange reserves as the channels since most of these countries use their reserves from the restricted export earnings to intervene in the foreign exchange market to maintain the official rate. The magnitude and significance of the negative effect of fixed policy regime on FDI increased indicating that fixed regime is not a good policy in period of current account imbalance and depleting foreign exchange reserve. It is therefore recommended that monetary authorities in these countries especially in periods of depleting foreign reserve and current account imbalances allow the market to determine the exchange rate or reduce their intervention so as to eliminate unnecessary uncertainties that hinders FDI flow to the zone.