The effect of exchange rate volatility on foreign direct investment and portfolio flows to Thailand

Abstract

This paper aims to examine the question of whether exchange rate movements and exchange rate risk impact the overall flows of foreign direct investment (FDI), FDI at sector level, and portfolio flows at firm-specific level to Thailand. To analyze the effect on FDI, this paper conducts a time-series model by regressing the exchange rate movements and exchange rate risk on the overall FDI and FDI at industry level. The result, based on monthly data from 2001 to 2009, suggest that exchange rate movements influence the aggregate FDI, machinery and transportation equipment, chemicals, textiles, finance institutions, and investment sectors. The exchange rate risk is statistically significant for machinery and transportation equipment, chemicals, food and sugar, finance institutions, mining and quarry, petroleum products, and services industries. As expected, FDI responsiveness to exchange rate movements and exchange rate risk varies across industries as different industries expose to exchange rate movements and exchange rate risk differently. For the link between exchange rate movements, exchange rate risk and foreign portfolio flows to Thailand. This study employs panel data analysis in order to estimate the model of foreign portfolio investment at firm-level. Based on the monthly data covering the period 2005 to 2009, the results reveal that appreciation of THB against other currencies in the bundle raises the firm-specific foreign portfolio inflows to Thailand. Regarding the exchange rate risk, the link between exchange rate risk and foreign portfolio investment is negative indicating that high exchange rate risk lowers firm-specific foreign portfolio flows to Thailand.