SYMMETRIC IMPACT OF EXCHANGE RATE VOLATILITY ON FOREIGN DIRECT INVESTMENT IN PAKISTAN: DO THE GLOBAL FINANCIAL CRISES AND POLITICAL REGIMES MATTER?

Abstract

Understanding currency fluctuations carries a high level of risk. A currency can slide or spike as a response of an economic indicators revelation or an unexpected political event, both of which are unforeseeable. As foreign investors become more optimistic about the country’s future, a healthier economy usually requires a strong currency. Therefore, it is necessary to assess the exchange rate volatility risk in the context of direct investment in order to develop preventive policy routes that would encourage foreign investors into the country. To this purpose, the autoregressive distributive least square (ARDL) technique has been employed to investigate the symmetric effect of exchange rate volatility on foreign direct investment (FDI) during global financial crises and political regimes from January 2000 to December 2018. In order to eliminate arbitrariness, the study uses the most accredited estimate of volatility, GARCH (1 1), as part of the re-estimation process. Besides this, the interaction has been studied under various regimes to see how the political environment affects foreign market participants’ expectations for future gains. The findings suggest that exchange rate volatility is adversely related to FDI and is a source of decreased net foreign investment in Pakistan. It also illustrates that during times of crises and apolitical regimes, Pakistan’s average FDI falls dramatically. The findings are extended to the context of Pakistan that has seen significant rupee volatility for the past few years. Our study recommends that policymakers should pursue exchange rate measures that promote exchange rate stability, which might assist to minimize risk of exchange rate volatility and so attract higher FDI. It is also crucial to formulate more sustainable investment methods that allow for efficient capital allocation during times of economic uncertainty.