The Effect of Exchange Rate Volatility on International Trade and Foreign Direct Investment (FDI) in Developing Countries along “One Belt and One Road”

Rashid Latief,Lin Lefen

doi:10.3390/ijfs6040086

Abstract

The “One Belt and One Road” (OBOR) project was started by the Chinese government with the aim of achieving sustainable economic development and increasing cooperation with other countries. This project has five major objectives, which include (i) increasing trade flow, (ii) encouraging policy coordination, (iii) improving connectivity, (iv) obtaining financial integration, and (v) fortifying closeness between people. This paper aims to analyze the effect of exchange rate volatility on international trade and foreign direct investment (FDI) in developing countries along “One Belt and One Road”. We selected seven developing countries which are part of this project, namely Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka. We collected panel data for the period 1995 to 2016 from the U.S. Heritage Foundation, International Financial Statistics (IFS) (a database developed by the International Monetary Fund), and World Development Indicators (WDI) (a database developed by the World Bank). We applied Generalized Autoregressive Conditional Heteroscedasticity (GARCH) (1,1) and threshold-Generalized Autoregressive Conditional Heteroscedasticity (TGARCH) (1,1) models to measure the exchange rate volatility. Furthermore, we employed a fixed effect model to analyze the relationship of exchange rate volatility with international trade and FDI. The results of this paper revealed that exchange rate volatility affects both international trade and FDI significantly but negatively in OBOR-related countries, which correlates with the economic theory arguing that exchange rate volatility may hurt international trade and FDI. It can be concluded that exchange rate volatility can adversely affect international trade and FDI inflows in OBOR-related countries.

Highlights

The “One Belt and One Road” (OBOR) project was initiated by Chinese President Xi Jinping as a regional development strategy and focuses on the economic development and cooperation of China with other countries
We selected the sample of seven developing countries along “One Belt and One Road”, namely Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka based on the availability of data to investigate the relationship between exchange rate volatility and international trade and foreign direct investment (FDI)
As mentioned in the introductory section, the objective of this paper is to analyze the effect of exchange rate volatility on international trade and FDI by focusing on developing countries that are part of “One Belt and One Road” project, which comprises Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka

Summary

Introduction

The “One Belt and One Road” (OBOR) project was initiated by Chinese President Xi Jinping as a regional development strategy and focuses on the economic development and cooperation of China with other countries. The main purpose of this project is to promote the development of China, especially simultaneously in central and western regions, along with promoting economic development in Central Asia. The countries along the OBOR have the potential to open new markets for China to improve trade and investment activities (Ding et al 2017). As a result of this project, trade and investment activities in participating countries will be accelerated. These activities are associated with the variations in the exchange rate of those countries

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Conclusion