Abstract
Although it is widely recognized that Foreign Direct Investment (FDI) inflows have a dominant effect on economic growth of host countries, the determinants of FDI inflows are still unclear. Especially, about the effect of exchange rate on FDI inflow, the results reached by scholars vary across countries or regions. It is of great practical and theoretical significance to explore the influencing effects of exchange rate on FDI inflow and identify the mechanisms that underlie them in close association with regional economic characters so as to help local government implement targeted government policies to achieve sustainable FDI inflow and sustainable economic growth. For this purpose, the influencing effects and the influencing mechanisms of the exchange rate on FDI inflows are investigated for Zhejiang province, China, over 1985–2019 by employing the co-integration tests, vector error correction models, Granger causality tests, and impulse response tests. Empirical results indicate that there are long-term stable and unidirectional causal relationship between the exchange rate and FDI inflow. Continuous appreciation of RMB against USD discourages FDI inflow. The mechanism which underlies the long-term relationship is the wealth effect, rather than the cost effect or the demand effect. By contrast, in the short run, neither the exchange rate nor the three influencing mechanism has a significant impact on FDI inflow. These results suggest policy recommendations for improving FDI by accumulating human capital and improving infrastructure. These findings are also applicable for other countries or regions with similar economic characters.
Highlights
Foreign Direct Investment (FDI) refers to the investment behaviour in which the investing country uses capital for the production and operation in the host country to own part of management rights, which is one of the main forms of modern capital internationalization
FDI inflow contributes a lot to economic growth of host country in introducing advanced technology and mature management experience, helping host country to integrate into the global market network [2,3,4,5]
Different from the cost effect and wealth effect, the demand effect indicates a positive effect of exchange rate on FDI inflow: when the currency of host country appreciates, their gross domestic product (GDP) measured in foreign currencies will increase, which will expand local demand and attract market-oriented FDI [21, 22]
Summary
Foreign Direct Investment (FDI) refers to the investment behaviour in which the investing country uses capital for the production and operation in the host country to own part of management rights, which is one of the main forms of modern capital internationalization. Different from the cost effect and wealth effect, the demand effect indicates a positive effect of exchange rate on FDI inflow: when the currency of host country appreciates, their gross domestic product (GDP) measured in foreign currencies will increase, which will expand local demand and attract market-oriented FDI [21, 22]. Because the conclusions based on nationwide data are not necessarily applicable for a regional economy, it is of great practical significance to analyse the specific impact effect and specific impact mechanism of exchange rate on local FDI inflow based on the characteristics of local economy, which can better guide local government to implement policies to enhance FDI inflow and promote economic growth.
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