Foreign Exchange Risk in the FDI decision: A Case Study of Myanmar Currencyâ€™s Exchange Rates
Keywords:Foreign Exchange Risk, Overvalued Currency, Equilibrium Exchange Rate, Bayesian Estimation, Myanmar Exchange Rate
Businesses engaging in foreign direct investment (FDI) need to assess foreign exchange risk of the host country. Such risks are determined by the movements and volatility of rates. The exchange rate of a currency can be overvalued or undervalued with reference to the Purchasing Power Parity (PPP) and the equilibrium exchange rate. The equilibrium exchange rate determination is challenging and constrained by data availability, time horizon and methods. A currencyâ€™s current level of value (either overvalued or undervalued) and its tendency to depreciate or appreciate can affect FDI decision and strategies. The assessment and management of foreign exchange risk exposure is so crucial to international firms that the assessment should be executed before the FDI decision and for the long-term.
This paper focuses on the theoretical aspects of foreign exchange rate, particularly the value position in comparison with equilibrium exchange rate. The empirical study was conducted for the currency (Kyat) of Myanmar which is considered as overvalued in the past. We employed an econometric model to estimate the exchange rates based on selected macroeconomic variables. The parameters were estimated using the Bayesian Averaging Method (BMA) available in the R statistical open-source software. The results of empirical study showed that Myanmarâ€™s exchange rates were moving in alignment with the economic fundamentals of the country, and shows a depreciating trend. Since Myanmarâ€™s currency is believed to be still overvalued and the economy is in transition, the paper concluded that FDI decision should be made cautiously.
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