An empirical analysis of the effect of exchange rate on foreign direct investment in Ghana

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In spite of the several policies being implemented by the government of Ghana to enhance the flow of FDI into the economy, available data indicates that the level of FDI inflows has also been falling. This is worrying for a nation like Ghana which depends so much on FDI for growth and development. In the same vein, the exchange rate of the Cedi to major trading currencies has also been increasing. This is a key factor which most foreign investors before embarking on an investment in a nation, take into consideration. This call for this study which seeks to analyse the effect that exchange rate has on foreign direct investment in Ghana using annual time series data covering the period 1980 to 2013. The study employs the ARDL technique to empirically ascertain the long run and short run relationship between the variables. The study finds that exchange rate has a negative effect on foreign direct investment inflows in Ghana both in the long run and short run. However, the negative effect of exchange rate on FDI is only statistically significant in the short run. This shows that a depreciation of the Ghanaian cedi brings about a decrease in the FDI inflows into the economy. Therefore, to ensure high FDI inflows into the economy, there i s the need for the central Bank of Ghana to embark on a contractionary monetary policy in order to reduce money supply in the economy. The decrease in money supply would bring about an increase in interest rate and hence make domestic interest bearing assets more lucrative. This will cause both local and foreign investors to demand these interest bearing assets which in turn brings about an increase in the demand for the cedi. The resultant effect would be an appreciation of the Cedi and hence an increase in FDI inflows.
A thesis submitted to The Department of Economics in partial fulfilment of the requirement for the award of the degree of Master of Philosophy in Economics, 2016