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| How Do RMB Exchange Rate Fluctuations Affect Chinese Enterprises' Outward Foreign Direct Investment？ |
| CHEN Lin, YUAN Zhigang, ZHU Yifan
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School of Economics, East China Normal University;
School of Economics, Fudan University |
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Abstract In 2005, China launched an RMB exchange rate reform. The previous fixed exchange rate system was replaced with a managed floating system. The RMB exchange rate consequently began to experience volatility. In 2015, the People's Bank of China modified the pricing mechanism to a daily fixed price. Since then, there have been sharp fluctuations in the exchange rate, which have triggered a large-scale capital outflow. After several years of rapid growth, China has shifted from being a major destination of foreign investment to one of the world's leading foreign investors. When enterprises engage in foreign investment, they are involved in currency exchange. Thus, fluctuations in a country's exchange rate will inevitably impact enterprises' foreign investment decisions. Given the increasing fluctuation of the RMB exchange rate, it is necessary to study the influence of this trend on the outward foreign direct investment (OFDI) decisions of Chinese enterprises.
Based on the China Global Investment Tracker Database compiled by the Heritage Foundation from 2005 to 2017, we study the impact of RMB exchange rate fluctuations on Chinese enterprises' OFDI. We also draw on the China Listed Enterprises Database managed by Ifind, the IMF International Financial Statistics, the World Bank's World Development Indicators and Worldwide Governance Indicators. Based on these measures of exchange rate fluctuation, we use linear probability model, probit, and logit methods to estimate the impact of exchange rate fluctuations on the probability of Chinese firms' engaging in outward foreign investment. We use a tobit model to estimate the impact of exchange rate fluctuations on the volume of Chinese firms' OFDI. We also apply a Heckman two-stage selection model to reduce sample selection bias. Our study shows that fluctuations in the RMB exchange rate and increased uncertainty significantly depress the probability of Chinese enterprises' OFDI and the volume of investment. Next, we take into account endogeneity issues, rare event bias, sample selection bias, and different exchange rate fluctuation indicators. In addition, based on manually collected corporate annual report data, we find that the hedging behavior of enterprises in the foreign exchange market can help them avoid exchange rate risks, which weakens the suppression effect of exchange rate fluctuations on investment. Further research shows that exchange rate fluctuations have heterogeneous effects on companies that invest in different industries and countries and use different investment methods. This is the result of several unique characteristics of China's foreign investment.
The contributions of this paper are as follows. First, it provides micro-level evidence of the impact of exchange rate changes on Chinese enterprises' outward investment, enriches the literature on the factors affecting Chinese OFDI, and expands research on the impact of exchange rates on firms' internationalization decisions. Previous studies focus on the relationship between exchange rates and firms' exports; few studies analyze exchange rates and firms' OFDI from a micro perspective. This article offers a preliminary exploration of this topic. Second, the data used in this article have some unique features. The China Global Investment Tracker Database includes firms' OFDI volume, and can thus be used to study the impact of exchange rate changes on companies' investment decisions and investment volume. This database also traces each investment to its final destination, overcoming the problem of returning investments that could not be avoided with the previous OFDI statistical database. Whereas the previous literature mostly focuses on Chinese manufacturing enterprises' OFDI, the dataset used in our study includes enterprises in various industries, such as finance, real estate, energy, transportation, and manufacturing. This makes it more representative and comprehensive. Third, the manually collected annual reports can truly reflect companies' risk management of exchange rates. Our study finds that companies reduce exchange rate risk by hedging in the FX derivative market, which weakens the restraining effect of exchange rate fluctuations on corporate investment.
In future research, it will be important to establish a theoretical model based on the characteristics of Chinese firms to explain the impact of exchange rate fluctuations on their OFDI behavior. Future studies could also examine the impact of exchange rate expectations on Chinese companies' overseas investment.
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Received: 13 February 2018
Published: 30 March 2020
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