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FDI Inwards and Exchange Rate Volatility: Causality Evidence


Given discrepancies between emerging and developed economies in
terms of FDI inwards, this paper tests for the causality relationship
between FDI inflows and its determining factors, namely foreign
exchange rate and foreign exchange rate volatility during the period
1990‐2016. In addition, this paper explores what policy implications can
be structured in order to stimulate higher rates of FDI inflow, in one
hand, and how to smooth FDI inwards volatility, in the other hand. The
paper is motivated by the fact that FDI (as gigantic capital inflows)
creates some sort of pressure on the exchange rate of the host
currency, causing in turn trade competitiveness reduction of thehost
economy, given the impact that can be made on interest rate
differentials and/or other macroeconomic attributes. The vector
autoregressive model (VAR) is applied to test for the short‐term and
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long‐term Granger causality between the targeted variables. Whereas,
the VAR indicates the existence of Granger causality between variables,
the direction of causality is detected by the vector error correction
model (VECM).
Key words: Real exchange rate, Real exchange rate volatility, FDI inwards,
Economic Growth, Openness, Panel data
Corresponding Author’s E‐mail Address: [email protected]
JEL Classifications: F31, F21, F65, O55, C23
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