FOREIGN DIRECT INVESTMENT AND EXCHANGE RATES: A CASE STUDY OF U.S. FDI IN EMERGING MARKET COUNTRIES

Manop Udomkerdmongkol, Holger Görg and Oliver Morrissey

Discussion Papers from University of Nottingham, School of Economics

Abstract: This 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. Threevariables are used to capture separate exchange rate effects. The nominal bilateral exchange rate tothe $US captures the value of the local currency (a higher value implies a cheaper currency andattracts FDI). Changes in the real effective exchange rate index (REER) proxy for expected changes inthe exchange rate: an increasing (decreasing) REER is interpreted as devaluation (appreciation)being expected, so that FDI is postponed (encouraged). The temporary component of bilateralexchange rates is a proxy for volatility of local currency, which discourages FDI. The results supportthe ‘Chakrabarti and Scholnick’ hypothesis that, ceteris paribus, there is a negative relationshipbetween the expectation of local currency depreciation and FDI inflows. Cheaper local currency(devaluation) attracts FDI while volatile exchange rates discourage FDI.

Date: 2006-05
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Working Paper: Foreign Direct Investment and Exchange Rates: A Case Study of US FDI in Emerging Market Countries (2008)
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