Effect of exchange‐rate volatility on foreign direct investment in Sub‐Saharan Africa

Abstract

Purpose The present study aims at using a broader data set and longer time frame coupled with a relatively rigorous and robust methodology to examine the effect of real exchange rate volatility on foreign direct investment (FDI) in a small and developing country such as Ghana. Design/methodology/approach Time series data covering the period 1970‐2002 were used. ARCH and GARCH models were employed for the determination of real exchange rate volatility, and co‐integration and ECM were used to determine both the short‐ and the long‐term relationships. Findings The study showed that the volatility of the real exchange rate has a negative influence on FDI inflow and that the liberalization process has not led to a greater inflow of FDI in Ghana. It is also revealed that while both the stock of FDI and political factors are likely to attract FDI, most foreign investors do not consider the size of the market in making a decision to invest or otherwise in Ghana. Originality/value The main contribution of the study is its departure from the use of ratios in examining the effect of real exchange rate risk on FDI to a more rigorous and robust methodology, coupled with the fact that studies of this nature are virtually non‐existent in Ghana.