Exchange Rate Volatility and Its Impact on FDI Inflows in India Using Maki Cointegration Approach

This paper examines the impact of exchange rate volatility and FDI inflows in India for the period 2000 to 2019 on a monthly basis. The role of exchange rate and its fluctuations possess a vital role in influencing key macro-economic variables in any economy. The present study has been significantly important to assess the exchange risk which arises when exchange rate of any country has been too volatile which impacts the international trade and investment decisions. It has utilized the technique of Generalized Autoregressive Heteroscedasticity as a proxy variable in order to capture the volatility in exchange rate of India. To investigate the cointegration between FDI inflows and exchange rate volatility, the approach of Maki cointegration which provides information up to five unknown structural breaks has been employed. Further, a comparative analysis of simple ARDL and ARDL with structural breaks has been analyzed. Firstly, the result of cointegration by Maki approach has been consistent with ARDL bound test. The model with structural breaks stood superior as its ARDL bound test was far higher than simple model and it also removed the problem of heteroscedasticity which was observed in model 1 (simple ARDL). The findings suggest that exchange rate volatility has been negatively associated with FDI inflows in both the models signifying that volatility in exchange rate deter FDI inflows due to uncertainty which rises among foreign investors regarding the returns, though it was negative but statistically insignificant in our study.