Exchange Rate Policy and the Relative Distribution of FDI between Host Countries

This paper examines the FDI and exchange rates nexus in the context of one FDI source and two host countries. It focuses on the effect of exchange rates on the relative FDI inflows between the two host countries. The theoretical analysis shows explicitly that the relative FDI inflows are a function of the relative real exchange rate. In particular, if one host country devalues its currency against that of the source country more than the other does, FDI into the country will be expected to increase relatively while FDI into the other decrease. The theoretical inference is examined with Japanese FDI in China and ASEAN-4 (Indonesia, Malaysia, the Philippines and Thailand). The empirical results generally support the theoretical conclusion, suggesting that the real devaluation of the Chinese Yuan undercut FDI into the ASEAN-4.