The Impact of Exchange Rate Volatility on Foreign Direct Investment Inflows: Evidence from South Asia
Purpose: The purpose of this paper is to empirically assess the impact of exchange rate volatility on foreign direct investment (FDI) inflows in Bangladesh, India, Pakistan, Nepal and Sri Lanka. To this day, neither empirical nor theoretical research has managed to reach any consensus on the nature of this impact. Design/Methodology/Approach: The paper uses panel data from the aforementioned developing South Asian countries over the period 1980-2017. Since volatility is not directly observable, a GARCH (1,1) model is used to generate data on exchange rate volatility. The exchange rate volatility variable is then used along with other control variables to analyze the impact on FDI. The study further proceeds by estimating fixed-effect models on the panel of countries using Driscoll and Kraay (1998) standard errors. Findings: Results suggest that exchange rate volatility has a significant negative impact on FDI inflows in South Asian countries, which are in much need of greater inflow to accelerate their economic growth. However, the negative impact of volatility may be offset via greater trade openness. Practical Implications: South Asia imposes strict trade restrictions but greater trade openness can smoothen the path for FDI inflows. Originality/Value: This paper empirically depicts the negative impact between exchange rate volatility and FDI inflows as well as the importance of trade openness in South Asia.