On the Relation between Exchange Rates and Domestic Investment: Asymmetric Evidence from China's 31 Provinces

• Published date: 01 December 2022
• Author: Guimin Lu,Jungo Baek,Soojoong Nam
• Date: 01 December 2022
• DOI: http://doi.org/10.1111/1467-8462.12479

The Australian Economic Review, vol. 55, no. 4, pp. 477–488 DOI: 10.1111/1467-8462.12479

On the Relation between Exchange Rates and Domestic

Investment: Asymmetric Evidence from China's 31 Provinces

Guimin Lu, Jungo Baek and Soojoong Nam*

Abstract

The current paper investigates whether the

exchange rate asymmetrically inf‌luences do-

mestic investment in China. To this end, the

nonlinear autoregressive distributed lag

(NARDL) process is applied to investment

data disaggregated by China's 31 provinces.

We discover that there is evidence that the ups

and downs of the yuan have asymmetric

impacts on domestic investment for some

provinces, though not all, in both the long‐

and short‐run.

JEL CLASSIFICATION

C22; F31; O53

1. Introduction

Many studies explore the impacts of changes in

exchange rates on a country's domestic invest-

ment. Some studies, for example, f‌ind that a

reductioninacurrency'svalueislikelytopush

up a country's exports and its GDP as a result.

Since business decision makers know that an

expanding economy means strong sales and

improved prof‌it margins, f‌irms would invest

more in business expansion and new construc-

tion. With currency depreciation, therefore,

domestic investment tends to rise. Among

others, see Nucci and Pozzolo (2001), Landon

and Smith (2009) and Berg et al. (2015). Others,

in contrast, reveal that currency depreciation

would likely drive down the prof‌itability of

f‌irms because the import prices for which they

can produce their products go up. Thus, this

currency depreciation effect contributes to

downward pressure on domestic investment.

Some examples include Campa and Goldberg

(1995, 1999), Forbes (2002) and Harchaoui,

Tarkhani and Yuen (2005). Unquestionably,

previous research has advanced our under-

standing of the response of domestic investment

to exchange rate f‌luctuations.

Important, but perhaps less widely recognised

in prior empirical research, however, is the

possibility that f‌luctuations in exchange rates

asymmetrically inf‌luence domestic investment. In

other words, past studies typically assume that

the currency depreciation impacts on domestic

investment are the exact opposite of those of

currency appreciation. Since prices in various

sectors of the economy tend to be rigid

* Lu: Department of Finance and International Trade,

Kongju National University, 56 Gongjudaehak, Gongju,

Chungcheongnam‐do, Korea; Baek: Department of

Economics, University of Alaska Fairbanks, 213B

Bunnell, Fairbanks, Alaska 99775‐6080, USA; Nam:

Department of International Trade and Commerce,

Kongju National University, 56 Gongjudaehak, Gongju,

Chungcheongnam‐do, Korea. Corresponding author:

Baek, email: <jbaek3@alaska.edu>.

© 2022 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business

and Economics.

Published by John Wiley & Sons Australia, Ltd