Exchange Rate, Uncertainty and Foreign Direct Investment Inflow in West African Monetary Zone

Abstract

Exchange-rate movements are mostly unpredictable, and this tends to affect both trade and foreign investment flows. This is because foreign investors are unclear on the returns to investment decisions in such cases. Hence, this study examines the effect of exchange rate, its volatility and uncertainty on foreign direct investment (FDI) inflow in West African monetary zone (WAMZ). The study covers the period1980–2014, and the within estimator for the fixed effect model is employed. The study accounts for both exchange rate volatility and uncertainty measures which are anticipated and unanticipated exchange rate innovations measures, respectively. The results show that exchange-rate movements in WAMZ countries are more of unanticipated than anticipated innovations in affecting FDI inflow. Therefore, policies aimed at targeting exchange-rate stability are essential in the WAMZ countries since investors are profit maximizers; hence, investment uncertainties must be kept as low as possible. Also since WAMZ export sectors are primary products based, policies should be geared towards the diversification of the export sectors to combat unanticipated global shocks from commodity prices movement in having an effect on the exchange rate through the foreign exchange reserve channel.