The Impact of USD exchange rate fluctuations and macroeconomic factors on foreign direct investment inflows in Sri Lanka

Abstract

TheprimaryaimofthisresearchistoinvestigatetheimpactoffluctuationsintheUSD exchange rate (as the U.S. dollar (USD) holds a dominant position in global trade and financial markets) on foreign direct investment inflows into Sri Lanka, placing exchangeratestabilityasacriticalfactorinattractinginvestment. Furthermore,there- search will consider how the fluctuations of other important factors like GDP growth, inflation, and trade openness influence the FDI inflows in Sri Lanka. These variables were chosen based on their theoretical and empirical importance in FDI literature and their relevance to the Sri Lankan economic context. By understanding these factors, thisstudyaimstoprovidecomprehensiveinsightsintotheeconomicfactorsthatinflu- ence FDI inflows especially during times of currency fluctuation. The analysis establishes both long- and short-run relationships between the iden- tified variables using the Autoregressive Distributed Lag Model (ARDL). ARDL is particularly suitable for this research as it accommodates variables of different levels ofintegration(i.e.,I(0)andI(1)). Thetestresultsindicateapresenceofthelong-runre- lationship between FDI inflows and the selected other variables. In additionally, Error CorrectionModel(ECM)isappliedtoobserveshort-rundynamicsandtheadjustment mechanism toward the equilibrium in the long run. Results from this study show that GDP growth has a positive and significant impact on FDI inflow, both in the short and long run. The error correction term is highly significant with a negative coefficient signifyingthatthespeedofadjustmenttowardthelong-runequilibriumishigh. Inthis respect,itisfoundthatalmost86%ofdisequilibriumiscorrectedinshort-runperiods. The data have been analyzed on the statistical software Eviews. These insights hold significant implications for policymakers, as they highlight the need to stabilize key economic indicators to enhance Sri Lanka’s attractiveness as a destination for foreign investment