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Exchange rate strategies in the competition for attracting FDI

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Author Info
Agnes Benassy-Quere
Lionel Fontagne
Amina Lahreche-Revil

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Abstract

The financial crises of 1997-1998 have highlighted the destabilizing impact of short run capital flows to emerging countries. By contrast, foreign direct investment (FDI) is widely viewed as a stable source of financing for developing countries. However, the debate on the way to re-orient capital flows towards long term financing (through microeconomic reforms or capital controls) does not generally include the choice of an exchange-rate regime. Here the choice of an exchange-rate regime is re-considered by integrating the determinants of multinational firms locations. We consider the case of a risk-adverse multinational firm which contemplates relocating two alternative foreign locations in order to re-export. We explicit the trade-off between price competitiveness and a stable nominal exchange rate. We also show that the firm will consider both locations as substitutes or as complements depending on whether the two exchange rates against the investing country's currency are positively or negatively correlated. The theoretical model is estimated on a panel of 42 developing countries receiving FDI from 17 OECD countries, over 1984-1996. The results confirm the importance of the exchange-rate regime. Specifically, nominal exchange rate instability is detrimental to foreign direct investment, and its impact compares with that of misalignments. In addition, from the perspective of the host country, the correlation between its bilateral exchange rate against the origin country and the one of alternative locations has a sizable impact on inward FDI.

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Paper provided by CEPII research center in its series Working Papers with number 1999-16.

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Date of creation: Dec 1999
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Handle: RePEc:cii:cepidt:1999-16

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Related research
Keywords: Exchange rate regime; FDI; Currency blocks;

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Find related papers by JEL classification:
F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
F31 - International Economics - - International Finance - - - Foreign Exchange
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Robert E. Lipsey & Robert C. Feenstra & Carl H. Hahn & George N. Hatsopoulos, 1999. "The Role of Foreign Direct Investment in International Capital Flows," NBER Chapters, in: International Capital Flows, pages 307-362 National Bureau of Economic Research, Inc. [Downloadable!]
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  5. Lionel Fontagné & Michael Freudenberg, 1999. "Endogenous Symmetry of Shocks in a Monetary Union," Open Economies Review, Springer, vol. 10(3), pages 263-287, July. [Downloadable!] (restricted)
  6. Tamim Bayoumi & Peter Isard & Steven A. Symansky & Takatoshi Ito, 1996. "Exchange Rate Movements and Their Impact on Trade and Investment in the APEC Region," IMF Occasional Papers 145, International Monetary Fund.
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  8. Linda S. Goldberg & Michael W. Klein, 1997. "Foreign Direct Investment, Trade and Real Exchange Rate Linkages in Developing Countries," NBER Working Papers 6344, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Ignatius J. Horstmann & James R. Markusen, 1990. "Endogenous Market Structures in International Trade," NBER Working Papers 3283, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Klein, Michael W. & Rosengren, Eric, 1994. "The real exchange rate and foreign direct investment in the United States : Relative wealth vs. relative wage effects," Journal of International Economics, Elsevier, vol. 36(3-4), pages 373-389, May. [Downloadable!] (restricted)
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  14. Joseph E. Stiglitz, 1999. "Reforming the Global Economic Architecture: Lessons from Recent Crises," Journal of Finance, American Finance Association, vol. 54(4), pages 1508-1522, 08. [Downloadable!] (restricted)
  15. Barrell, Ray & Pain, Nigel, 1998. "Real Exchange Rates, Agglomerations, and Irreversibilities: Macroeconomic Policy and FDI in EMU," Oxford Review of Economic Policy, Oxford University Press, vol. 14(3), pages 152-67, Autumn.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ayako Saiki, 2005. "Asymmetric Effect of Currency Union for Developing Countries," Open Economies Review, Springer, vol. 16(3), pages 227-247, July. [Downloadable!] (restricted)
  2. Olivier Rouguet & Pierre Villa, 2000. "Le passage des retraites de la repartition a la capitalisation obligatoire : des simulations a l'aide d'une maquette calibree," Working Papers 2000-02, CEPII research center. [Downloadable!]
  3. Brahim Razgallah, 2004. "La théorie des ZMO s'applique-t-elle aux pays en développement?," International Finance 0403003, EconWPA. [Downloadable!]
  4. Lahcen ACHY & Juliette Milgram, 2005. "Does a free trade area favors an optimum currency area? The Case of Morocco and the European Union," International Trade 0512012, EconWPA. [Downloadable!]
  5. Kawai, Masahiro & Takagi, Shinji, 2000. "Proposed strategy for a regional exchange rate arrangement in post-crisis East Asia," Policy Research Working Paper Series 2503, The World Bank. [Downloadable!]
  6. Keith Head & Thierry Mayer, 2002. "Illusory Border Effects: Distance Mismeasurement Inflates Estimates of Home Bias in Trade," Working Papers 2002-01, CEPII research center. [Downloadable!]
  7. Isabel Ruiz, 2005. "Exchange Rate as a Determinant of Foreign Direct Investment: Does it Really Matter? Theoretical Aspects, Literature Review and Applied Proposal," International Trade 0511016, EconWPA. [Downloadable!]
  8. PONSOT, Jean-François, 2000. "Le Currency Board : les contraintes de financement et d'ajustement de la convertibilité intégrale," LATEC - Document de travail - Economie (1991-2003) 2000-10, LATEC, Laboratoire d'Analyse et des Techniques EConomiques, CNRS UMR 5118, Université de Bourgogne. [Downloadable!]
  9. Loic Cadiou & Julien Genet & Jean-Louis Guerin, 2002. "Evolutions demographiques et marche du travail : des liens complexes parfois contradictoires," Working Papers 2002-16, CEPII research center. [Downloadable!]
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