Finding Analysis & Discussion
Exchange rate has a significant impact on foreign currency and the international trade market (Foo 2014). Exchange rate fluctuations may affect economic growth and foreign direct investments. FDI inflows increase when there is a decline in exchange rate. An increase in exchange rates causes a decline in commodity prices in the host country. Investors will purchase products at subsidized prices, therefore, causing an increase in the purchasing power. The costs of operation will decrease which causes the profit margin to increase. A company’s primary goal is to makes sustainable profit (Tran 2015).Therefore, if FDI firms experience lower costs, they increase the number of their operations in a host country.
Exchange rate’s influence on FDI in developing countries
Developing countries have experienced immense growth with the increase in foreign currency rate. In 2013, the total FDI into BRICS was $322 billion (Prabhakar et al. 2015).An increase in the exchange rate increases the country’s wages and production costs. In such a country, an investor has to terminate his business to avoid making negative returns.
In 1976-1986, the analysis revealed that the exchange rate had a positive impact of FDI. There was a positive relationship between the Japanese yen and the U. S. dollar (Kogut& Chang 1996).In the period of 1976-1986, there had been an increase in the Japanese yen. Thus, the FDI in the U. S. increased. Japanese investors in the U. S. took advantage of the increasing currency rate in their home country. Therefore, when they transferred money from the U. S. to their countries of origin, they realized that it had a higher value due to the increased exchange rate. This led to more investments supporting the U. S. monetary policies in order to get more returns. Exchange rates correlate with the inflows and outflows of FDI. An inflow of the FDI can stimulate the local currency both positively and negatively, which leads to various monetary outcomes (Lily et al. 2014).
Exchange rate influence on FDI on developed countries
The U. S. dollar has a direct impact on the BRICS countries. An increase or decrease in the exchange rate reduces the depreciation of the local currency (Lily et al. 2014).An increase in foreign exchange increases the prices of goods, hence, causing a reduction in the purchasing power of any currency. Inflation has significant effects on the exchange rate in developing countries compared to developed ones. In case of increase of the exchange rate in a developed country, the central bank will introduce financial tools to control an unreasonable exchange rate. However, exchange rates are controlled with much more efficiency in developed countries, rather than developing countries. When BRICS countries experience growth in the exchange rates, the FDI inflows increase correspondingly, because the foreign companies get significant returns (Siddiqui 2014).Subsequently, this increases the gross domestic product (GDP), thereby leading to stable economic growth. In the recent decade, the FDI inflows have declined drastically. This has been attributed to lack of economic growth.FDI is established to operate under a vibrant economy to make positive yields.
FDI and BRICS Economy
BRICS is an acronym which represents the following countries: Brazil, Russia, India, China and South Africa. Originally, before the introduction of South Africa in 2010, the countries were four, and they were referred to as the Big Four. These countries are grouped in that manner, due to tremendous economic growth over the past years. Also, they have attracted an influx of investors, and so it was critical for them to come together – since they have a common agenda –and to draw a plan for future collaborative activities.
It has become vital for countries to achieve economic growth since that attracts FDI, and investors want to make high returns (Umaru & Zubairu 2012). BRICS countries have made tremendous growth in 2016.The gross domestic product for Brazil was 1.9.1 percent, Russia 2.45 percent, India had 3.92 percent, China 2.39 percent, and South Africa had 2.01 percent (Menon 2017).
BRICS countries have become adept in investigating economic growth because they represent about 40% of the total population worldwide (Nistor 2015).These countries are suited better than others for a working sample, since a study cannot be conducted taking every person in the world into account. The BRICS, therefore, are able to represent the majority of individuals in the whole world.
Secondly, BRICS economies constitute a larger percentage of the FDI inflows. In fact, in 2012, the BRICS economies contributed to 20% of the FDI across the globe (Nistor 2015).This proves that many investors are interested in these countries, and it would be most rational to determine their economic growth and the GDP.It is vital because it reveals the price of goods and commodities in those areas. Also, international investors improve the citizen’s living standards, by offering them employment opportunities.
Various factors contribute to the attraction of internationally recognized companies. For instance, China offers cheap labour, which encourages the investors because they are not required to spend greater sums on their operations. Brazil and Russia have natural resources such as oil that can potentially encourage investors, because they will spend fewer resources to import raw materials. India, in turn, has a younger population, and many investors prefer young people because they are energetic and can work for longer hours. Thus, it is evident that each BRICS country has a number of potential advantages over many developed countries.
Exchange Rate on BRICS Countries’ Economies
The exchange rate in the BRICS economies varies over time. Some countries such as China and South Africa have reported decreased annual growths at -0.07 percent each for the past fiscal year 2016 (Menon 2017).The high-interest rates have caused a slip over in volatility (Caporale, Spagnolo & Spagnolo 2017).The extreme decrease in foreign exchange rates has caused a decline in the FDI inflows because investors experience low-profit margins which are likely to result in unstable environment. However, there have been several meetings between the BRICS countries officials to discuss on mitigating extreme exchange rate fluctuations
The exchange rate has a significant impact on FDI inflows. For instance, if the USA has FDI in the BRICS countries, and the exchange rate declines, the FDI inflows from the USA would increase adequately. This occurs because it is cheaper for companies to carry out operations, due to the availability of affordable products. Consequently, this increases profit and they invest more in the BRICS countries. This discussion will take a closer look at the exchange rate level, exchange rate volatility and exchange rate expectations regarding the FDI.
The Exchange Rate Level and its impact on FDI
Exchange rate fluctuations may have positive or detrimental effects on FDI. When the exchange rate is low, foreign capital increases since the cost of importing and exporting is relatively minimal. When foreign companies borrow more money to invest overseas, they must pay extra costs to monitor all their investments.
There have been various studies conducted on the impact of FDI in the BRICS countries. Specifically, a study was carried out to determine the impact of exchange rate on FDI in China and India. It was concluded that there was a negative correlation between the exchange rate and the FDI made in both countries (Khandare 2016).For instance, in the year 1991-2014, In China, the exchange rate would increase the FDI by 0.605 units in India. Therefore, if the exchange rate decreased in China, more foreign investors would consider setting up industries in India. If China’s currency is performing well, the FDI would decrease by 0.2503 units (Khandare 2016). Decreased investments have a negative impact on exchange rates (Jordaan 2013).In case there is a high foreign currency rate in China, the prices of goods and commodities for both the local and multinational companies would increase, hence, resulting in a high rate of inflation. A high inflation rate occurs when prices increase, thereby, decreasing the purchasing power of the currency. This would discourage investors from collaborating with China, because it would reduce their profit margins contrary to their primary objective of achieving high returns.
Over the years, FDI have contributed immensely to the economic growth and international competitiveness in the developing countries. If there is an increased inflow of FDI, the local exchange rate decreases due to the imperfect market conditions. For instance, if the US investors are located in the BRICS countries such as India, they will borrow their capital from the US. Afterwards, the money will be invested in India. Since there would be a major supply of goods, the foreign exchange rate will decrease because there is no money in circulation.
In a survey by Lily et al. (2014) carried out to examine the relationship between exchange rates and FDI, it was evident that currency rates movements were largely dependent on the FDI. The study also determined that many foreign firms gain a competitive edge over the local forms because of sourcing their funding abroad. They further indicated that most multinational enterprises obtain financing abroad due to cheaper interest rates, the stable foreign currency (Lily et al. 2014). When repaying the loan, don’t pay back exorbitant prices when the currency is stable. If a currency is weak, it may lead to high interest rate fluctuations which reduce the profit margins of a company. Therefore, to protect themselves from foreign exchange fluctuations, multinational enterprises hedge from exchange risk, by borrowing from their home country. Also, the study indicates that countries faced with currency depreciation, experience low production costs. This occurs because there is an excess supply of money and more goods which make the cost of buying raw materials cheap.
In summary, it is clear that when there is an increase in FDI, the exchange rate decreases. This occurs because international companies source funding from their home countries, which contributes to additional capital in the local market. This creates competition with the local industries, because they cannot fairly compete in a market where their competitors have more capital than them.
Exchange Rate Volatility and FDI
A foreign currency rate determines the financial position of a company. If the currency rate increases, it has negative effects on a company, because it will pay more than it borrowed hence resulting in massive losses. Volatility indicates uncertainty, in the present, and near future (Kennedy &Nourzad 2016). Exchange rate volatility means that a currency is bound to experience fluctuations and they must have an impact on the business. Most companies take protective measures to avoid exchange rate fluctuations. Such measures include opting for a fixed interest rate, because at the end of the borrowing period, the multinational company will pay the agreed amount of coupon rate.
Exchange rates have a control over the domestic price level. Exchange rate volatility has a negative impact on FDI inflows, and a positive influence on price (Dal Bianco & Loan 2017).A fluctuation on macro variables such as interest rates has a significant impact on the exchange rate, and economic growth (Udoka & Anyingang 2012). When there is an increase in inflation rate, investors avoid excessive importation of goods, and this enhances business growth and profitability. On the contrary, if there is a declined interest rate, borrowing rate increases. This causes increased demand supply of goods in the market. Borrowers and lenders infiltrate the market, leading to lower prices due to increased supply of goods, and services. Therefore, FDI inflows increase due to cheap and affordable goods and services.
Volatility maximises returns (Cristina &Gheorghe 2014).BRICS economies especially China, experience high volatility rates, causing them to have a robust economic growth. These rates increase the prices of goods and the profit margins which has positive effects on the business. On the other hand, it causes negative effects for the consumer. When prices are high, consumers reduce the intake of a commodity.
Finally, it is clear that exchange rate volatility has a significant effect, especially on the FDI inflows to the BRICS countries (Pineda 2014).Some findings have established that high exchange rates increase commodity prices, which hurts the FDI inflows to the BRICS countries (Dal Bianco& Loan 2017).However, other findings claim that exchange rate volatility has a positive impact on FDI inflows to the BRICS countries, because it increases yields on the investors (Cristina& Gheorghe 2014).It is apparent that exchange rate volatility has a negative effect on FDI inflow in the BRICS countries. When there is an increase in the exchange rates, foreigners have to pay more money to obtain the same number of goods. FDI experience decreased sales, causing them to leave the country to search for better environment.
Exchange Rate Expectation and FDI
An exchange rate expectation is a factor that any investor needs to consider before starting a business. An investor must find the evidence of inelasticity to predict the future spot rates. Here, they must look at the supply and demand of goods in a particular area, and determine whether the price change will affect the consumer behaviour. This way, they can categorically state whether the exchange rate will appreciate or decline rather than investing carelessly. Investors who don’t take the time to analyze the exchange rate and have expectations have always been affected by the exchange rate shock. Some studies assert that exchange rate expectations do not have an impact on future exchange rates (Beckmann &Czudaj 2017). The authors argue that in case of extreme exchange rate fluctuations, the central bank needs to intervene. It may be difficult to predict future exchange rates since shock can be experienced due to prior decisions (Goldbaum & Zwinkels 2014).
Various models are used to determine the expected exchange rate (Hodrick 2014).These models include the local model which is used to estimate the future spot exchange rate. It studies the link between money supply and prices. The model states that if there is increased the money supply in the economy, production will increase, hence increasing the exchange rate. The author further claims that in order for exchange rates to be predicted correctly, it is vital to consider changes in the monetary policy. An effective monetary policy ensures control of the supply of the currency, as well as a controlled inflation and exchange rate. Therefore, a controlled exchange rate assures investors of a safe business environment hence increasing the rate of FDI in the BRICS countries.
Most investors prefer investing in a country where there is minimal variance in the exchange rate (Bilawal et al. 2014).Therefore, to calculate the expected rate, they take the actual rate, and subtract it from the expected exchange rate. The investors can predict the expected rate by using the current measurements. If the exchange rate increases, they will increase the prices, and increase their returns. On the contrary, if the exchange rates decrease, they will experience massive losses and eventually lead to the cessation of the business activities. Exchange rates are vital to the economy, because they determine macroeconomic effects such as the gross national product and the FDI (Khattak, Tariq & Khan 2012). When the exchange rate is high, the gross domestic product will increase because of the increased value of the goods and services (Hatane& Teddy 2014). FDI has been discovered to have a significant impact on the growth of the gross domestic product (Hussain & Haque 2016). When international companies invest in a country, they produce high-quality products which cause them to increase their prices. Also, they offer employment opportunities to most of the citizens which increases their income and improve their living standards.
It is clear that FDI play a major role in a country’s economic growth. Foreign investors bring cash inflows into the host country which improves the country’s per capita income, and the living standards. In the recent decade, there has been an influx of FDI in the BRICS countries creating competition among the host countries. A decline in foreign exchange rate has attracted FDI, because it lowers their operating costs. When imports are cheap, the foreign companies import raw materials to the host countries to aid in production. This reduces the production cost and the investors are required to provide greater sums. They have to pay taxes to the host government. If taxes are used efficiently and effectively, they improve on service delivery of the country’s population. Therefore, to foster economic growth, a country must control exchange rates, which leads to an increase in FDI.Many FDIs prefer countries experiencing economic growth, compared to dormant economies. FDI increases the state’s revenue. Addition of income aids in service delivery to the country’s population. There is competition among local companies, because they are focusing on producing high-quality products to compete with products from the international firms. Therefore, FDI contributes to the growth of local businesses which forces local companies to enhance quality products, thereby, providing the country with quality goods which meet international standards.
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