Causality Analysis of Foreign Direct Investment, Exchange Rate and Interest Rate Volatility in Ghana

Abstract

Increasingly, Foreign Direct Investment is assuming a prominent role in the development and growth strategies of developing and emerging countries. Using a Vector Autoregressive (VAR) model, this study demonstrates theoretically that exchange rate volatility have an impact on Foreign Direct Investment. It then provides an empirical illustration of the bias this endogeneity can cause when regressing measures of exchange rate volatility on foreign direct investment. It is a detailed study that uses pairwise granger causality test. The study also establishes that a stable exchange rate improves Foreign Direct Investment inflow into the country and likewise a high FDI inflow improves stability of exchange rate in the country. It also demonstrates that interest rate volatility directly affects exchange rate and market attractiveness which then affects Foreign Direct Investment in the long run. The paper therefore concludes that government should implement policies that will stabilize both the exchange rate and the interest. The study therefore suggests policies that will improve FDI inflows.