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Exchange Rate, Exchange Rate Regime and Outward Foreign Direct Investment

Author: XiaLiangKe
Tutor: ZhouLiQun;XieSiQuan;ZhouBing
School: Nankai University
Course: Political Economics
Keywords: Exchange rate exchange rate volatility outward foreign direct investment ARDL bounds testing approach
CLC: F224
Type: PhD thesis
Year: 2010
Downloads: 524
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Since the reform and open policy, China achieved great success in attracting foreign direct investment (FDI); in particular since 1990s, China has become one of the countries which got most FDI inflow. FDI played a vital role to the Chinese economy development, and a great number of researches concentrated in this; however, this is little research on China’s outward foreign direct investment (OFDI) because the mount of China’s OFDI was small in a long time. Nevertheless, OFDI has increased rapidly in recent years; especially the "Going-abroad Strategy" was enforced in the beginning of 21centry. The ratio of FDI to OFDI was 1:0.5 in 2008, which is larger than the average level of developing countries which is between 1:0.2 to 1:0.43, but still smaller than developing countries. China is transferring from a most important FDI inflow country to a large FDI outflow country. Furthermore, China’s OFDI will keep increasing as recent years in a long period in the future accompanying with Chinese economy growth, the increasing double-surplus in current and capital accounts and the improvement of domestic corporations’ competitiveness. Therefore, it is an important topic for researchers to investigate the development of China’s OFDI.Meanwhile, China’s exchange rate regime has also experienced tremendous change since 1949. There are two significant reforms should be emphasized, the first time was in 1994 when China announced to implement managed floating exchange rate regime, the official exchange rate was depreciated from RMB 5.8 to RMB 8.7 per USD in January 1,1994, and the nominal exchange rate stabilize since then. The second important reform happened in July 21,2005 when China reformed the RMB exchange rate regime by moving to a managed float based on market supply and demand with reference to a basket of currencies. As a result, a more market-oriented foreign exchange management mechanism established and the floating band is getting larger and larger. According to the existing research, not only the exchange rate level change can affect OFDI, the exchange rate volatility is also a determining factor when an enterprise makes decision to invest abroad.Although a great deal of scholars studied the relationship between exchange rate and the transnational direct investment since 1970s, but, no unified theory system is established up to now, moreover, there are big difference in various results both from theoretical analysis and from empirical research. The difference rose partially because of the complications of transnational direct investment behavior, partially because of the difference in countries’development stages, exchange rate regime, market structure and so on. As far as I know, most of the existing studies on exchange rate and OFDI based on developed countries’examples, especially on America, Japan and European countries, but little research focus on developing countries.Based on China’s case, this paper tries to achieve two goals. Firstly, by exploring the short-term shocks and long-term influence of RMB real exchange rate change and exchange rate volatility impact on China’s OFDI, I want to analyze the relationship between RMB real exchange rate and China’s OFDI in term of Chinese national condition and compare with the existing literature. Secondly, I try to figure out how exchange rate works on OFDI in several outstanding developing economies and developed economies in the world using same empirical method, and compare the different results between developing economies and developed economies from the whole and the individual level. In particular, I compare the results of China’s case with other economies and investigate why the difference happened and extend our understanding on the relation between exchange rate and OFDI in developing economies.In addition to the data description analysis, some modern econometric analysis method such as generalized impulse response function (GIRF), variance decomposition, and the newly developed general autoregressive distributed lag (ARDL) model bounds testing approach also are used in this paper. According to my knowledge, there is little paper studied on RMB exchange rate and the Chinese OFDI, it is the first time using normative econometric method to compare the difference between developing economies and developed economies as this paper.The main results of this paper can be summarized as follows:Firstly, up to 2008, the number of Limited Liability Company occupied 50.2% Chinese multi-enterprises, while the proportion of state-owned enterprises dropped dramatically. However, state-owned enterprises still play a dominant role in China’s OFDI in terms of investment stock. Moreover, the average scale of China’s multi-enterprises is small and mainly concentrates in the manufacturing industry. Most of China’s OFDI lies in Hong Kong and tax heaven such as British Virgin Islands and Cayman Islands which always be treated as investment transfer facility or tax evasion by China’s corporation, as a result, the real region and industry distribution of China’s OFDI were concealed to a large extent. Similar to the feature of global transnational investment, cross-border M&A also becomes the main mode of China’s OFDI and large M&A increased significant. In addition, most of Chinese M&A were conducted by leading corporations of various industries, especially by state-owned enterprises.Secondly, actually, the RMB exchange rate only appreciates unilaterally against the U.S. dollar although RMB exchange rate regime has transformed from fixing to the dollar to referring to the currency basket in July,2005. Furthermore, the volatility of RMB real purchasing power decreased after the reform of RMB exchange rate regime in July,2005 in terms of the appreciation of real effective exchange rate compared to the reform of RMB exchange rate regime in 1994.In the third place, The positive relation between RMB real exchange rate appreciation and China’s OFDI only establish in the short-term; while in the long-term, the depreciation promote the increase of China’s OFDI. However, the positive relation between exchange rate volatility and China’s OFDI is found both in short and long term. The China’s OFDI is less influenced by RMB real exchange rate change, while sensitive regarding to the exchange rate volatility.In addition, the OFDI increase is helpful for dissolving pressures for RMB appreciation, and increase RMB exchange rate volatility too.The results show that for developing economies, not only real currency appreciation but also exchange rate volatility is significant positively relate to OFDI both in the short term and in the long run; however, for developed economies, the same positive relation only exist in the long run. The coefficient of exchange rate and exchange rate volatility is larger for developed economies due to well developed financial system and more competitive market structure in the long term; while the OFDI of developing economies is more sensitive than developed economies in the short run on account of little experience on investing abroad.Finally, the study on individual economies indicates that OFDI is influenced more significant in float exchange rate regime than fixed exchange rate regime. The response of China’s OFDI is different from other economies owing to its OFDI dominated by state owned enterprises, the moral risk of managers, and the potential capital flight.

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CLC: > Economic > Economic planning and management > Economic calculation, economic and mathematical methods > Economic and mathematical methods
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