Empirical Relationship between Foreign Direct Investments and Exchange Rates in the Post Liberalization Era

Abstract

This paper tries to investigate the long term and short term causal relationship between foreign direct investment (FDI) and foreign exchange rates (FX) in India's post liberalization period. Econometric models have been used in this study, and the long term relation between FDI and FX is measured by using Johansen's cointegration test, and Granger's causality test is employed to measure the short term relationship. The result of the cointegration test proves that there is a significant long-term relationship between foreign direct investment (FDI) and foreign exchange rates (FX) with the exception of YEN/INR. The short-term relationship test confirms that there exists uni-directional relationship between FX and FDI. Therefore, FX has a stronger ability to predict subsequent FDI inflows, whereas there is no implication vice versa.