The relationship between foreign direct investments and exchange rates - A quantitative analysis of how the exchange rate is affecting the FDI inflows in South Korea and China

Abstract

This study investigates the effect of exchange rate movements on foreign direct investment (FDI) inflows. According to previous studies, it seems to be a significant correlation between exchange rate movements and the FDI inflows. However, the result differs depending on different factors and motives. During the last decades, the economic growth within South Korea and China has been massive. Each country has had an annual average growth rate of approximately 10 percentage. Furthermore, South Korea is perceived as an open country with a floating exchange rate. China is rather seen as a closed country with a fixed exchange rate. In order to analyze the relationship between exchange rate movements and FDI inflows, we created an econometric model where our dependent variable is the annual FDI inflow and the independent variable of interest is the real effective exchange rate. Based on our results, we can conclude that there is a significantly negative correlation between real effective exchange rates and FDI inflows so that an appreciation (depreciation) of the local currency leads to a decrease of FDI inflows (increase of FDI inflows).