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

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. Three variables are used to capture separate exchange rate effects. The nominal bilateral exchange rate to the $US captures the value of the local currency (a higher value implies a cheaper currency and attracts FDI). Changes in the 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 temporary 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 currenc