Financial Risks Of Foreign Direct Investment Liberalization

The paper firstly makes clear definitions of foreign direct investment and financial risk in different perspectives. It systematically analyzes literatures on the positive effects and economic risks caused by foreign direct investment. Furthermore, research progress on financial risks brought by foreign direct investment is introduced in detail. Through the analysis of the present situation in China, the paper points out that generally the financial system is stable, however, the frequent foreign direct investment flowing will lead to financial risk increase.Based on the above research, the paper establishes panel data model, simulation analysis method and tail breakpoint VAR model to study the impacts on financial risks from foreign direct investment liberalization. Results show that for emerging economies the savings rate rise will reduce financial risk, while the increase in the real exchange rate and internal rate of return may make domestic financial risk rise dramatically. Higher financial development standard might worsen the domestic financial stability condition. Foreign direct investment has different degree of marginal effects on financial risks. Through the reduction of saving rate and internal rate of return, foreign direct investment is good for financial stability. If real exchange rate decreases, foreign direct investment will have a positive effect on financial stability. For developed economies, the saving rate will do good to financial risk decrease. The real exchange rate and internal rate of return rise will lead to financial risks. Foreign direct investment has different degree of marginal effects on financial risks. Foreign direct investment can reduce financial risk through real exchange rate devaluation. Foreign direct investment can make financial risk decrease by the reduction of domestic output volatility. Different from emerging economies, under certain circumstances, foreign direct investment growth can increase domestic financial risk.Simulation results indicate that U.S. government should pay moderate attention to foreign direct investment, if real exchange rate devalues, they should reduce foreign direct investment to ensure the controllable scope of financial risks. Regardless of internal rate of return changes, macro-policy authorities should strengthen the control of foreign direct investment. Because internal rate of return increase will cause financial risks growth, therefore the U.S. government should maintain a cautious attitude to benchmark interest rate rise. According to the simulation result, China monetary authorities should pay enough attention to foreign direct investment flowing. If saving rate rises, financial risk will decrease. Regardless of real exchange rate changes, financial risk will rise. Macro-authorities should reduce the real exchange rate fluctuations to decrease financial risk. If internal rate of return falls significantly, domestic financial risk will decline. When financial development standard rises, a certain extent of domestic financial risk will appear, causing financial instability. Therefore monetary authorities need highlight financial risks when they encourage and promote financial innovation.Tail breakpoint VAR model shows that before financial crisis, industrial added value growth will cause financial risks. But the inter-bank lending rate fall will significantly reduce the level of financial market risk. If the observation period contains financial crises, the inter-bank lending rate decrease will also effectively avoid financial market risks. If observation period becomes shorter, long-term cointegration relationship will have structural breakpoints and it also doesn't exist robustness. Foreign direct investment changes will not have remarkable impact on financial market fluctuations, that is to say, domestic macro-policy measures in China have succeeded in avoiding asset bubble risks. Most important is, the long-run equilibrium relationship exists structural breakpoint around October,2008.The main reason is probably due to the influence of international financial crisis, such as the foreign direct investment flowing decrease.The above conclusion demonstrates foreign direct investment may directly contribute to financial risk expansion, so the government should fully consider its negative effects. Accordingly, the domestic financial environment and macro-economic financial policy must be adjusted based on foreign direct investment flowing to reduce potential financial risks. Successful macro-policies should contain the stable exchange rate, investment environment improvement, financial asset bubbles prevention, financial development standard control, the speculative capital control and foreign direct investment optimization to eliminate financial risk because of direct foreign investment liberalization and effectively avoid financial risks to ensure economic and financial stability.