ASYMMETRIC EFFECTS OF EXCHANGE RATE UNCERTAINTY AND POLITICAL RISK ON FOREIGN DIRECT INVESTMENT IN EAST ASIA: EVIDENCE FROM DYNAMIC PANEL ANALYSIS

Abstract

This study investigates the asymmetric effects of exchange rate uncertainty and political risk on Foreign Direct Investment (FDI) inflows in East Asia over the period 1990–2022. While East Asia remains one of the world's most attractive destinations for FDI due to its robust market size, trade openness, and high returns on investment, persistent macroeconomic and political uncertainties pose significant challenges to sustaining these capital inflows. Employing advanced econometric techniques, including ARCH/GARCH models to estimate exchange rate volatility and the Arellano-Bond Generalized Method of Moments (GMM) dynamic panel estimator to address endogeneity concerns, this research explores how these risks asymmetrically influence FDI behavior. The findings reveal that market size, trade openness, and investment returns positively and significantly affect FDI inflows, whereas inflation exerts a negative influence. Surprisingly, infrastructure quality has a significant negative relationship with FDI under uncertainty, suggesting that economic and political instability may overshadow the benefits of physical infrastructure improvements. Asymmetric analysis confirms that negative exchange rate shocks deter FDI, while positive shocks have an insignificant effect, highlighting the risk aversion of multinational investors. Furthermore, positive developments in external conflict management, internal stability, and soundness in law and order significantly encourage FDI, while other governance factors like corruption control and bureaucratic quality showed no notable influence. This study contributes to existing literature by adopting a nonlinear, asymmetric framework to analyze the complex dynamics of uncertainty and investment in East Asia. It offers valuable policy insights, emphasizing the need for stable macroeconomic environments, predictable currency regimes, and effective political risk management to attract and retain foreign investment in the region.