RMB Exchange Rate And Foreign Direct Investment

Foreign direct investment has made a strong contribution to the development of China's economy since the Open-door policy took effect thirty years ago. According to a range of economists, the rapidly growing amount of FDI was due to past undervaluation of the RMB. However, on July 21, 2005, China carried out its RMB exchange rate reform and started to peg its efforts on a variety of currencies, rather than solely on the U.S. dollar. Since this reform took effect, the RMB nominal exchange rate steadily appreciated against the U.S. dollar. What effect does the appreciation of RMB have on China's FDI inflow? Furthermore, will the expectations of the RMB's appreciation do harm to foreign investment? Nowadays. we could see that some Chinese industries other than manufacturing are attracting more and more FDI inflow, such as the real estate industry and finance service industry. Is this change due to the RMB appreciation? These are some of the questions we seek to address in this thesis.Based on solid literature reviews on exchange rate and foreign direct investment, this thesis firstly makes proper assumptions according to the characteristics of FDI inflow to China, to find the mechanism of the exchange rate effect on FDI. Next, we utilized practical analysis using quarter data from 1995 to 2007. The error correction model helped us find long-term, as well as short-term, effects of the RMB exchange rates on FDI inflow to China. We find that the short-term effects of exchange rate volatility was significant, as well as the long-term effect of exchange rate level. Finally, we employed the Granger Causality Test on these effects and found that the exchange rate volatility did Granger Cause the FDI inflow to China, while the exchange rate level not.The findings of this thesis implies that since the possibility of RMB depreciation in the near future is relatively insignificant, keeping the stability of the RMB exchange rate seems crucial to attract FDI inflow. Additionally, we suggest the implementation of suitable policies to induct and supervise the FDI inflow to China.