Numerous
researches have attempted to establish the link between FDI and macroeconomic
performances including GDP, however, the results are rather mixed. Many papers
have mentioned that FDI influence growth in various ways, others have portrayed
the negative influence of FDI to economic growth and others showed
insignificant results. Balasubramanyam, Salisu and Sapsford argued that FDI can
speed up growth of the receiving countries through improving foreign trade and
ensuring stability of macroeconomic variables [18]. Further, they concluded
that FDI inflows can effectively boost economic growth than local investments
in developing economies which implement export promotion policies. For nations
with high institutional competence, FDI has a significant beneficial influence
on their growth. Nyiramahoro study on Uganda's macroeconomic dynamics, the
objective of studying relationships among GDP growth, Gross Capital Formation
(GCF), population growth, and net inflows of Foreign Direct Investment (FDI) by
applying the endogenous growth theory [19].
The study follows a quantitative approach by adopting a descriptive and
econometric design to investigate the relationship among the aforementioned
variables. The methodological tools were Descriptive statistics, stationarity
tests, multicollinearity testing, cointegration testing, and ARDL model
estimation. They found out that relative stability in GDP growth to the highly
volatile GCF growth and smooth population growth trends to negative net inflows
indicated by FDI. This confirms the long-run cointegration between the
variables, whereby GCF proves to be firmly and positively related to GDP
through an ARDL model. In contrast, variables FDI and population growth become
influential after due lags. The results show that Uganda needs domestic and
foreign investment to maintain economic growth; however, it has to deal with
disinvestment challenges and an increasing population for long-term stability.
They found out that capital formation and foreign investment are integral to
the Ugandan economy and can, if managed appropriately, ensure continued growth
by overcoming these challenges in demography and investment. Makhetha and
Rantaoleng examined the long-run relationship among FDI, trade openness and
growth in Lesotho for the period 1980-2011 [20]. The results show a long-run
relationship between output, FDI and trade openness. The VAR Granger causality
shows a unidirectional causal relationship running from trade openness, FDI to
output and from output, FDI to trade openness. FDI was found to be
insignificant in explaining growth of output in both the long and short run.
Trade openness was found to be significant with a negative impact on output
growth in the long run but was found to be insignificant in the short run.
Encinas-Ferrer
and Villegas-Zermeno said that it has been assumed that foreign direct
investment (FDI) is an important factor of economic growth (EG). The reason for
this is that as investment is the dynamic element of gross domestic product
(GDP), therefore, FDI is the independent variable and GDP growth the dependent.
Recent studies in Argentina and Mexico have shown by the contrary that the
consistent increase of GDP is the attractor of FDI. In our investigation we
include other countries: China, Brazil, South Korea and Peru beside Mexico and
the results are consistent with the prior studies and were proved empirically
by testing causality in the Granger sense, adjusted by Toda and Yamamoto's
method using the software e-views. We found that FDI, as a percentage of total
gross fixed capital formation (GFCF), is so small that it has only a marginal
influence in economic growth. In this paper we show only the econometric
results for China. Makiela and Ouattara studied the impact of foreign direct
investment (FDI) on growth remains a thorny question for researchers and policy
makers [21]. At the theoretical level it has been argued that FDI is growth
enhancing. However, existing empirical studies have left researchers and policy
makers perplexed as these studies do not appear to find a strong relationship
between the two variables. Their paper departs from the existing literature by
exploring the transmission channels from FDI to growth. The results, based on a
sample of developed and developing countries over the period 1970–2007,
conclusively reveal that FDI affects growth via inputs accumulation but not the
total factor productivity growth channel. In other words, our results suggest
that factors other than FDI may have contributed to the increase in productivity
witnessed in developing countries in recent decades. Shittu studied the impacts
of foreign direct investment (FDI), globalization and political governance on
economic growth in West Africa. The empirical analysis also included the
interaction effect of political governance and FDI on the growth of the
sub-region, over the period of 1996–2016. The study employs the autoregressive
distributed lag technique on data obtained from the World Bank and the KOF
institute. The study findings suggest a positive relationship between
globalization and political governance on economic growth. Even though there
have been inconclusive results on the FDI–growth nexus, the authors found that
FDI stimulates the growth of the sub-region, while political governance enhances
the positive impact of FDI on economic growth. The other factors of growth
included are labor, capital and government size, whose effects on growth are,
respectively, negative, negative and positive.
The
governments of the West African countries promote policies that attract FDI
into the sub-region, so that economic performances may be enhanced. In
addition, the governments of the West African sub-region should work to reap
the benefits of globalization, by promoting the competitiveness of their local
economies in order to keep pace with the global markets. The
political-governance infrastructures should be overhauled; the culture of
accountability and transparency should be promoted, while all efforts should be
made to improve stability in the political environment in order to increase
investors' confidence in the West African economy. The study is the first to
single out the impacts of political governance, as categorized by the World
Bank, through both direct and interactive measures. Husain studied the Impact
of Foreign Direct Investment (FDI) on Economic Growth in Congo [22]. This study adopted secondary data collection
and found out that Foreign Direct Investment (FDI) has been widely studied FDI
inflows can stimulate economic growth by providing access to capital,
technology, and managerial expertise, which may enhance productivity and
efficiency in the host country's industries. Additionally, FDI often fosters
job creation and facilitates knowledge transfer, contributing to human capital
development and skill enhancement within the workforce and promote competition
and innovation, driving overall economic dynamism. He found out that
relationship between FDI and economic growth is contingent upon various factors
such as the quality of institutions, regulatory environment, infrastructure,
and host country policies. Weak institutional frameworks or inadequate
infrastructure may hinder the full realization of FDI benefits. There are
concerns about the potential for FDI to exacerbate income inequality and
exploit natural resources, especially in developing countries. Thus, while FDI
generally presents opportunities for economic growth, its impact is
multifaceted and context-dependent, requiring careful consideration of host
country conditions and policy frameworks. Sharifi and Mirfatah studied the
flows of foreign investment and sais that FDI are the fundamental elements in
the economical evolution of countries within the globalization process of
economy [23]. They mentioned that previous research on exchange rate shows its
significance as a key role in trades and flows of FDI. Although exchange rate
and FDI are empirically investigated but the relationship between the
volatility of exchange rate and flows of international investments is generally
not identified. Therefore, considering the importance of the subject discussed,
it is needed to consider the determinants of FDI specially the volatility of
exchange rate and provide better situations for attracting FDI in Iran. The
main goal of this study is evaluating the determinants of inward FDI
particularly volatility of exchange rate in Iran by using the Johansen and
Juselius's cointegration system approach model covering the period
1980Q2-2006Q3.
The
findings of this study reveal that gross domestic product, openness and
exchange rate to have positive relationship with foreign direct investment but,
world crude oil prices and volatility of exchange rate have negative
relationship with foreign direct investment. The empirical results obtained in
this paper recommend the economy Politicians in Iran to implement exchange rate
policies that promote stability of exchange rate, which could help reduce
exchange rate volatility in order to attract more FDI. Alfaro estimated the
effects of foreign multinational corporations (MNCs) on workers [24]. They
combined micro data on all worker-firm and firm-firm relationships in Costa
Rica with an instrumental variable strategy that exploits shocks to the size of
MNCs in the country. First, using a within-worker event-study design, they find
a direct MNC wage premium of nine percent. Next, they study the indirect
effects of MNCs on workers in domestic firms. As MNCs bring jobs that pay a
premium, they can improve the outside options of workers by altering both the
level and composition of labor demand. MNCs can also enhance the performance of
domestic employers through firm-level input-output linkages. Shocks to firm
performance may then pass through to wages. We show that the growth rate of
annual earnings of a worker experiencing a one standard deviation increase in
either her labor market or firm-level exposure to MNCs is one percentage point
higher than that of an identical worker with no change in either MNC exposure.
Finally, we develop a model to rationalize the reduced-form evidence and
estimate structural parameters that govern wage setting in domestic firms. We
model MNCs as paying a wage premium and buying inputs from domestic firms. To
hire new workers, domestic firms need to incur recruitment and training costs.
Model-based estimates reveal that workers in domestic firms are sensitive to
improvements in outside options. Moreover, the marginal recruitment and
training cost of the average domestic firm is estimated at 90% of the annual
earnings of a worker earning the competitive market wage. This high cost allows
incumbent workers to extract part of the increase in firm rents coming from
intensified linkages with MNCs.
Sadik
and Bolbol argued that FDI inflows had affected positively the GDP growth and
local investment in six Arab countries from 1978 to 1998. Moreover, Bengoa
found a positive association among FDI and GDP in 18 economies of South
America. Sokang found out that foreign direct investment had a favorable effect
on growth in Cambodia’s economy by examining data from 2006 to 2016.
Furthermore, Akiri, Vehe and Ijuo used VECM and determined positive impact of
inward FDI to Nigeria’s GDP growth during from 1981 to 2014. Lajevardi and
Chowdhury investigated the relationship between the real effective exchange
rate (REER) and its volatility with the net inflow of foreign direct investment
(FDI) to Canada, placing a novel emphasis on sector-level analysis [25]. The study
utilizes time series data from 2007 to 2022 and employs the autoregressive
distributed lag (ARDL) approach to assess short-run and long-run relationships
between the said variables. The findings reveal significant impacts of changes
in REER, its volatility, and GDP on net FDI in the short run, with lasting
effects of REER and its volatility, lagged GDP, and trade openness on FDI in
the long run. At the sectoral level, FDI inflows in energy and mining,
manufacturing, finance, and insurance exhibit significant sensitivity to
changes in REER. Simultaneously, the volatility of REER has a significant
impact on FDI inflows in manufacturing industries and the finance and insurance
sector in the short run. In the long run, REER exerts a significant influence
on the net FDI inflows in energy and mining, as well as manufacturing
industries. The asymmetry in findings suggests a need for sector-specific
attention to retaining and attracting FDI to Canada. Mishra and Jena examined
the determinants of foreign direct investment (FDI) flows from some leading
developed countries (the USA, Japan, Germany, the Netherlands, the UK and
France) into major four Asian economies (China, Korea, India and Singapore).
Using one basic and four augmented versions of gravity model technique, the
authors tried to examine the determinants of bilateral FDI flows in four major
Asian economies. The study used World Development Indicators, CEPII, KOF and
Heritage Foundation data for period 2001–2012. Findings The results revealed
that besides the market size for host and source country, other criteria such
as distance, common language and common border also influence foreign
investors. Other macroeconomic factors such as inflation rate and real interest
rate are among the key factors that attract more FDI. In addition to economic
factors, institutional and infrastructural factors such as telecommunication,
degree of openness, index of globalization and index of economic freedom also
stimulate the international investors from the developed world to the major
Asian countries. It is altogether possible that only a set of home country
specific characteristics or host country specific characteristics does not
matter when determining FDI. Most empirical studies using indices such as the
index of globalization and economic freedom are subject to certain
methodological limitations such as model selection, parameter heterogeneity,
outliers and moral hazard. More distance between the host and source country
would result in less FDI flows due to more managerial and raw material supply
chain cost.
Su
and Liu using a panel of Chinese cities over the period 1991–2010, they
examined the determinants of economic growth, focusing on the role of foreign
direct investment (FDI) and human capital [26]. Consistent with the predictions
of a human capital-augmented Solow model, they found that the growth rate
(along the path to the steady-state income level) of per capita GDP is
negatively correlated with population growth rate and positively correlated
with investment rate in physical capital and human capital. They established
that FDI has a positive effect on the per capita GDP growth rate and this
effect is intensified by the human capital endowment of the city. They latter
suggests that one way that human capital contributes to growth is to serve as a
facilitator for technology transfers stemming from FDI. They also established
that some suggestive evidence that the FDI-human capital complementary effect
is stronger for technology-intensive FDI than for labor-intensive FDI. Trang,
their paper examines and provides additional and relevant quantitative evidence
on the impact of foreign direct investment (FDI) on economic growth, both in
the short run and the long run-in developing countries of the
lower-middle-income group in 2000–2014 [27]. Various econometric methods are
employed such as the panel-based unit root test, Johansen cointegration test,
Vector Error Correction Model (VECM), and Fully Modified OLS (FMOLS) to ensure
the robustness of the findings. The results of this study show that FDI helps
stimulate economic growth in the long run, although it has a negative impact in
the short run for the countries in this study. Other macroeconomic factors also
play an important role in explaining economic growth in these countries. Money
supply has a positive effect on growth in the short run while total credit for
private sector has a negative effect. In addition, long-run economic growth is
driven by money supply, human capital, total domestic investment, and domestic
credit for the private sector. Based on these results, recommendations for the
governments of these countries have been developed. Blomstrom and Kokko
embarked on a cross-country empirical analysis with the overarching objective
of unraveling the intricate relationship between FDI and economic growth across
various developing economies. The study sought to delineate the diverse
channels through which FDI exerts its influence on economic growth while
discerning the heterogeneity of its effects across different nations.
Methodologically, the researchers undertook a rigorous regression analysis
leveraging data spanning several decades from numerous countries to construct a
comprehensive understanding of this complex relationship. The findings of the
study revealed a nuanced picture, indicating that the impact of FDI on economic
growth is contingent upon a myriad of factors, including institutional quality
and human capital. The study underscored the imperative of enhancing
institutional capacity and investing in education and training to maximize the developmental
dividends of FDI. Moreover, the study provided valuable insights for
policymakers, emphasizing the need for tailored strategies to harness the
potential benefits of FDI while mitigating associated risks effectively.
Sakyi
and Egyir said the Bhagwati hypothesis predicts a growth enhancing effects of
trade (exports) and foreign direct investment (FDI) interaction. They tested
the validity of the Bhagwati hypothesis by investigating the extent to which
the interaction of trade (exports) and FDI has had an impact on economic growth
for a sample of 45 African countries over the period 1990–2014. To do so, they
estimate an augmented endogenous growth model with the aid of a dynamic system
generalized method of moment (GMM) estimation technique, which adequately cope
with potential endogeneity issues. The findings reveal support for the Bhagwati
hypothesis and provide vital information for policy formulation aimed at
promoting more credible export-promotion strategies and channeling of FDI into
export-oriented sectors in long-term development strategies in African
countries. De Castro analyzed the foreign direct investment determinants in
Brazil and Mexico during the period 1990 to 2010, in order to identify common
and divergent characteristics that affect FDI's attraction. For this purpose,
it was constructed an analytical model estimated using the Vector Error
Correction Model (VEC). From the results, it was noted that in Brazil the main
multinationals’ strategy is the market seeking - linked to the size of the
domestic market-, and, in Mexico, the dominant strategy seems to be efficiency
seeking, related to the importance of trade liberalization and the historical
flows to attract FDI. Kyereboah?Coleman and Kwame study aimed at using a
broader data set and longer time frame coupled with a relatively rigorous and
robust methodology to examine the effect of real exchange rate volatility on
foreign direct investment (FDI) in a small and developing country such as Ghana
[28]. Design/methodology/approach - Time series data covering the period
1970?2002 were used. ARCH and GARCH models were employed for the determination
of real exchange rate volatility, and co?integration and ECM were used to
determine both the short? and the long?term relationships. Findings - The study
showed that the volatility of the real exchange rate has a negative influence
on FDI inflow and that the liberalization process has not led to a greater
inflow of FDI in Ghana. It is also revealed that while both the stock of FDI
and political factors are likely to attract FDI, most foreign investors do not
consider the size of the market in making a decision to invest or otherwise in
Ghana. El-Rasheed and Abdullahi examined the relationship between foreign
direct investment (FDI) and economic growth in Nigeria [29]. The study
investigated the relationship between economic growth (GDP), foreign direct
investment (FDI), gross fixed capital formation (K), total labour force (L)
and, exchange rate (RER). The study employs annual time series data covering
1990 up to 2020. Utilizing the auto-regressive distributed lag (ARDL) model,
the existence of long-run relationship between the independent and dependent
variables was found. Additionally, we conducted the granger causality test to
determine the direction of causality. The ARDL bounds testing result shows that
labor has a long-term negative impact on economic growth, with foreign direct
investment, exchange rates, and capital having a positive influence. The
empirical findings from a pair-wise Granger-causality model showed the
existence of a bidirectional relationship between FDI and economic growth.
Based on our findings, we further suggest that the government should pursue a
strategy to attract FDI by enhancing Nigeria's business climate, environment,
and infrastructure. To increase investor trust, the government should continue
to execute sensible policies through the central bank with a goal of achieving
stable exchange rates. Additionally, through enhanced educational policy, the
government should aim to improve human capital and skilled workforce in the
nation.
Alfaro
delved into the realm of Latin American economies with the aim of unraveling
the intricate nexus between FDI, productivity, and economic growth. The study
embarked on an empirical journey to elucidate how FDI inflows shape
productivity levels and, by extension, contribute to sustained economic growth
in the region. Methodologically, the researchers undertook a meticulous
analysis, leveraging firm-level data and employing sophisticated econometric
techniques to disentangle the complex dynamics at play. The findings of the
study unveiled compelling evidence of the positive impact of FDI on
productivity growth, thereby bolstering economic expansion. By elucidating the
mechanisms through which FDI fosters technological spillovers and enhances
productivity, the study offered valuable insights for policymakers.
Recommendations included fostering an enabling environment for innovation and
knowledge transfer to fully harness the transformative potential of FDI for
sustainable economic development in Latin America. Asiedu embarked on an
empirical investigation focusing on Sub-Saharan African economies to discern
the impact of FDI on economic growth in the region [30]. The study sought to
assess whether FDI inflows stimulate economic growth or impede domestic investment
and growth dynamics. Methodologically, the research adopted a dynamic panel
data analysis approach, enabling a nuanced exploration of the long-term
relationship between FDI and economic growth. The findings of the study yielded
mixed results, underscoring the heterogeneous nature of FDI's impact across
different countries. While some nations reaped significant benefits from FDI
inflows, others experienced limited or adverse effects on economic growth. In
light of these findings, the study advocated for tailored policy interventions
aimed at bolstering absorptive capacity and enhancing infrastructure to
maximize the developmental dividends of FDI across Sub-Saharan Africa. Batten
and Vinh Vo using panel data for 79 countries, for the period of 1980-2003,
suggest, that the “analysis supports the view that FDI has a stronger positive
impact on economic growth in countries with a higher level of education
attainment, openness to international trade and stock market development, and a
lower rate of population growth and lower level of risk [31]. Also, studies in
the East Asian economies, aiming to unravel the intricate interplay between
FDI, financial development, and economic growth. The study sought to analyze
how financial sector development moderates the impact of FDI on economic growth
dynamics. Methodologically, the researchers employed panel data analysis and
interaction models to discern the nuanced relationships among FDI, financial
development indicators, and GDP growth rates. The findings of the study
underscored the pivotal role of a well-developed financial sector in amplifying
the positive effects of FDI on economic growth. Against this backdrop, the
study advocated for strategic interventions aimed at enhancing financial
infrastructure and regulatory frameworks to attract more FDI and catalyze
sustainable economic growth across East Asian economies.
Sharma
and Mavalankar embarked on a comprehensive empirical inquiry focusing on the
Indian economy, seeking to assess the multifaceted impact of FDI inflows on
economic growth and industrial development [32]. The study aimed to unravel the
sectoral distribution of FDI and its implications for economic growth dynamics
and structural transformation in India. Methodologically, the researchers
adopted a holistic approach, combining qualitative and quantitative analysis,
including case studies and econometric techniques. The findings of the study
unveiled compelling evidence of the positive contribution of FDI inflows to
economic growth, particularly in sectors such as manufacturing and services. In
light of these findings, the study underscored the imperative of promoting
policies conducive to attracting FDI inflows into priority sectors and regions,
thereby fostering inclusive growth and industrial diversification in India.
Durusu-Ciftci and Goktas embarked on an empirical exploration focusing on the
Turkish economy, aiming to analyze the impact of FDI on economic growth
dynamics and employment patterns [33]. The study sought to assess whether FDI
inflows have led to job creation and sustainable economic development in
Turkey. Methodologically, the research leveraged time-series data and
cointegration techniques to unravel the long-term relationship between FDI, GDP
growth, and employment levels. The findings of the study underscored the
positive influence of FDI inflows on economic growth and their significant contribution
to employment generation in Turkey. Against this backdrop, the study advocated
for strategic policy reforms aimed at enhancing the investment climate and
promoting technology transfer to maximize the employment effects of FDI,
thereby fostering sustainable economic development in Turkey. Kwaku studied
quantitative to ascertain the effect of foreign direct investment, real
exchange rate, remittances, and import on economic growth in Ghana [34].
Secondary data on gross domestic product, foreign direct investment, real
exchange rate, remittances, import, and gross capital formation from 1980 to
2018 were analyzed. The study employed Autoregressive Distributed Lag for the
econometrics analysis. The study found that foreign direct investment, real exchange
rate, remittances, imports, and gross capital formation cointegrates with
economic growth. The main findings are that foreign direct investment, real
exchange rate, import, and remittances matter from growth perspective.
Remittances have a positive and significant effect on economic growth in Ghana
both for the short run and the long run. The study also revealed that foreign
direct investment, real exchange rate, and imports have a negative and
significant effect on the growth process of Ghana’s economy for both the short
run and the long run. The study recommends that the Ministry of Finance, Ghana,
financial analysts and other policy makers should undertake steps to reduce
imports and attract more remittances inflows to attain long-run economic growth.
In addition, the economy must concentrate on viable exchange rate policies such
as undervaluation of currency to stimulate sustainable economic growth.
Kumari
and Kumar identified key determinants of foreign direct investment (FDI)
inflows in developing countries by using unbalanced panel data set pertaining
to the years 1990-2012 [35]. This study considers 20 developing countries from
the whole of South, East and South-East Asia. Using seven explanatory variables
(market size, trade openness, infrastructure, inflation, interest rate,
research and development and human capital), they tried to find the best fit
model from the two models considered (fixed effect model and random effect
model) with the help of Hausman test they found out fixed effect estimation
indicated that market size, trade openness, interest rate and human capital
yield significant coefficients in relation to FDI inflow for the panel of
developing countries under study. The findings reveal that market size is the
most significant determinant of FDI inflow. Their work also had some
limitations like lack of data on key determinants such as labor cost, exchange
rate, corruption, natural resources, effectiveness of rule of law and political
risk may be considered one such limitation. The study has significant
implications for policy makers, mangers and investors. Policy makers would be
able to understand the importance of the major determinants of FDI mentioned in
the paper, and take steps to formulate policies that encourage FDI. Such
measures could include developing market size, making regulations more
international trade friendly and investing in the nation’s human capital. Adam
examined the nexus between foreign direct investment (FDI), financial
development, and sustainable economic growth in Sudan during the period of the
structural adjustment program and the full Islamization of the banking and
financial system that took place in the 1980s. The research provides a
comprehensive analysis using the most recent time series secondary data from
1990 to 2020 and the study employed co-integration, Granger causality, and VAR
error correction technique to estimate the models, to clarify the claimed
relationship between FDI and its effect on the financial sector and
subsequently attending a sustainable economic development in Sudan. The results
of the ARDL bounds showed the existence of a long-term relationship between the
FDI and other independent variables but the short-term showed otherwise. The
Granger causality test implies that the past values of FDI don't significantly
contribute to the prediction of sustainable economic growth. Also, results show
that there's evidence of observed causality running from the country's trade
openness and the financial sector's development. The implication of these
results shows there is a complementary relationship between sustainable
economic growth and both financial development and trade openness in the short
run. Also, the study shows that the effect of financial development on economic
growth is further enhanced by the inflows of FDI. Sharma attempted to evaluate
the attractiveness of FDI in India in other words, the potential of India to
attract foreign direct investment. Secondly, the study investigates the role of
FDI potential in the real FDI inflow in the country [36]. The paper constructs
a comprehensive index for the attractiveness of foreign direct investment for
India, which reflects the preparedness or potential of the country to provide
an enabling environment for foreign investments. The study adopts principal
component analysis (PCA) to formulate an index that reflects socioeconomic,
political, and environmental aspects of FDI. Appropriate indicators are used to
reflect all the dimensions, such as social, political, environmental, economic,
infrastructure, and human capital. By regressing the FDI potential index on the
interest rate, final consumption, public–private partnership, and potential for
FDI on actual FDI inflow, the role of FDI potential is highlighted. It is
revealed that FDI potential and FDI inflows are significantly positively
correlated as well as significantly positively determine the FDI inflows as
revealed by the regression results. Therefore, infrastructure, socioeconomic
factors, and human capital also ensure political stability and governance are
favorable in promoting more FDI inflow. In addition, the policies favoring
public–private partnership and supporting all dimensions of FDI potential index
must be promoted.
According
to Alba Foreign exchange rates can both facilitate and potentially hinder
Foreign Direct Investment (FDI) and economic growth [37]. A currency
depreciation (making the host country's currency cheaper) can attract FDI by
lowering the cost of domestic assets for foreign investors. Conversely,
exchange rate fluctuations and uncertainty can make investment decisions more
complex and potentially deter FDI. When
a host country's currency depreciates, the cost of its assets becomes cheaper
for foreign investors, making them more attractive. This can increase the flow
of FDI into the country. Depreciation can also increase the relative wealth of
potential foreign investors, making them more willing to make large
investments. A weaker currency can make a country's exports cheaper and imports
more expensive, boosting export-oriented industries and potentially leading to
increased economic growth. A depreciation of the host currency can increase the
attractiveness of acquiring a foreign company. Fluctuations in exchange rates
can make it difficult for foreign investors to accurately predict their returns
and can lead to increased risk. Unpredictable exchange rates can also make it
more difficult for companies to assess their risk and can lead to reluctance to
invest. While depreciation can boost exports, it can also make imports more
expensive, potentially leading to higher prices for consumers and businesses,
which may impact economic growth negatively. If a country's currency
depreciates significantly, it can lead to higher import costs and inflationary
pressures, which can impact economic stability and investment. Therefore, foreign exchange rates play a
crucial role in influencing FDI and economic growth. While depreciation can
offer significant benefits in attracting investment and boosting exports, the
potential risks of exchange rate volatility and inflationary pressures must
also be considered. By increasing the relative wealth of foreign firms, a
change in the exchange rate can make it relatively easier for those firms to
use internal financing, thereby lowering the relative cost of investing.
Weinhold and Reichert (2001) found out remarkable increase in FDI flows to
developing countries over the last decade and focused attention on whether this
source of financing enhances overall economic growth. They used a mixed fixed
and random (MFR) panel data estimation method to allow for cross country
heterogeneity in the causal relationship between FDI and growth and contrast
our findings with those from traditional approaches. We find that the
relationship between investment, both foreign and domestic, and economic growth
in developing countries is highly heterogeneous and that estimation methods
which assume homogeneity across countries can yield misleading results. Our
results suggest there is some evidence that the efficacy of FDI in raising
future growth rates, although heterogeneous across countries, is higher in more
open economies.