Foreign Direct Investment and Uncertainty: Implications for Ethiopia

The paper examines the effect of price and exchange rate uncertainty and political instability on the inflow of Foreign Direct Investment (FDI) to selected African economies. Measures of uncertainty of inflation rate and real exchange rate are incorporated by taking the conditional variance of the residual of the Autoregressive (AR) processes of each series. Pooled data result without accounting for country specific factors is misleading. Fixed effects model provides a better explanation of the variation of FDI flow to African economies. The results show that uncertainty in the rate of inflation and political instability constrain the flow of FDI only when both are combined, and when they pass some threshold level. Real exchange rate volatility impedes the inflow of FDI only when its magnitude is low. When combined with political instability, real exchange rate has an unexpected significant positive impact on the flow of foreign direct investment. Domestic market size and market potential are not significant determinants of FDI inflow, but the volume of export attracts more FDI in the case where the stock of previous FDI is small