How does country risk matter for foreign direct investment?
In this paper, we aim to identify the political and financial risk components that matter mostfor the activities of multinational corporations. Our paper is the first paper tocomprehensively examine the impact of various components of not only political risk but alsofinancial risk on inward FDI, from both long-run and short-run perspectives. Using a sampleof 93 countries (including 60 developing countries) for the period 1985-2007, we find thatamong the political risk components, government stability, socioeconomic conditions,investment profile, internal conflict, external conflict, corruption, religious tensions,democratic accountability, and ethnic tensions have a close association with FDI flows. Inparticular, socioeconomic conditions, investment profile, and external conflict appear to bethe most influential components of political risk in attracting foreign investment. Among thefinancial risk components, only exchange rate stability yields statistically significant positivecoefficients when estimated only for developing countries. In contrast, current account as apercentage of exports of goods and services, foreign debt as a percentage of GDP, netinternational liquidity as the number of months of import cover, and current account as apercentage of GDP yield negative coefficients in some specifications. Thus, multinationals donot seem to consider seriously the financial risk of the host country.
|Date of creation:||Feb 2011|
|Publication status:||Published in IDE Discussion Paper = IDE Discussion Paper, No. 281. 2011-02|
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