Foreign Direct Investment and Exchange Rates: A Case Study of US FDI in Emerging Market Countries
The paper investigates the impact of exchange rates on US foreign direct investment (FDI) inflows to a sample of 16 emerging market countries using panel data for the period 1990-2002. Three variables are utilized to capture separate exchange rate effects. The bilateral exchange rate to the US$ captures the value of local currency (a higher value implies a cheaper currency and attracts FDI). Changes in real effective exchange rate index (REER) proxy for expected changes in the exchange rate: an increasing (decreasing) REER is interpreted as devaluation (appreciation) being expected, so that FDI is postponed (encouraged). The transitory component of bilateral exchange rates is a proxy for volatility of local currency, which discourages FDI. The results support the ‘Chakrabarti and Scholnick’ hypothesis that, ceteris paribus, there is a negative relationship between the expectation of local currency depreciation and FDI inflows. Cheaper local currency (devaluation) attracts FDI as volatile exchange rates discourage FDI.
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