The impact of exchange rate volatility on foreign direct investment and domestic investment in South Africa

Abstract

Foreign currency is a crucial part of globalization, thus after the adoption of the free floating system, the country experienced volatility in their currency. As a country known for its openness, foreign trade is an important part of the economy. However volatility of the country’s currency affects different aspect of the Macroeconomic environment which includes investments. The primary focus of this study is to examine empirically the impact of exchange rate volatility on foreign direct investment and domestic investment in South African for the period 1980 – 2015. The GARCH was used to measure volatility of exchange rate after which the study applied the Vector Error Correction Model method and Granger causality test to achieve the primary objective. The short-run analysis indicated a relationship between the exchange rate volatility, FDI and DI in South Africa. The long run showed FDI had a positive and statistically significant relationship with inflation rate, interest rate and export while a negative relationship with exchange rate volatility, GDP and Corporate tax was observed. From the DI model, the long run result indicates that there is a positive relationship between DI and exchange rate volatility, GDP and political stability while DI was observe to have a negative relationship with interest rate, inflation and export. This implies that 1 percent increase in variables with positive relationship with the dependant variables FDI and DI will increase the inflow of FDI as well as increase the rate of domestic investment. However, a 1 percent increase in variables with negative relationship will result in fall in FDI and DI in South Africa. Hence based on the long run results, the study, recommends policy implementation to increase inflation rate, interest rate and export in order to increase inflow of FDI while exchange rate volatility, GDP and Corporate tax should be monitored. The study also recommends that exchange rate volatility, GDP and political should be encouraged in order to increase the rate of DI in the country whereas, interest rate, inflation and export should be monitored so as not to decrease domestic investment.