Testing the Relationship Between Volatility of the Rate of Exchange and Foreign Direct Investment Inflows in Zimbabwe from 1995 to 2022

Abstract

The research examined the relationship between Volatility of the rate of exchange and Foreign Direct Investment inflows in Zimbabwe. The model was stated as Vector Error Correction Model (VECM), and the data was annual time series data from 1995 to 2022. Foreign Direct Investment, Exchange Rate, Inflation Rate, Gross Domestic Product Growth Rate and Interest Rates were the variables used. The empirical findings revealed that in the long run, Volatility of the rate of exchange had a significant negative impact on Foreign Direct Investment inflows in Zimbabwe, whereas Inflation Rate, Gross Domestic Product Growth Rate and Interest Rate had a positive impact that was statistically significant. The main policy recommendations were that the government needs to introduce or strengthen hedging mechanisms to protect investors against rate of exchange fluctuations. For instance, the government can consider establishing currency hedging instruments or providing incentives for investors to use financial derivative products to manage rate of exchange risks. This can help alleviate concerns about volatility and encourage more Foreign Direct Investment inflows.More so, the government may reduce overreliance on a single sector or industry to enhance Foreign Direct Investment resilience to volatility of the exchange rate. Encouraging diversification of the economy by supporting the growth of various sectors, such as manufacturing, agriculture, tourism, and services, can attract a broader range of investors. This diversification can help reduce the vulnerability of Foreign Direct Investment inflows to rate of exchange fluctuations The government can also provide information and support to potential investors regarding the impact of volatility of the rate of exchange and the available risk management strategies. The government can organize workshops, seminars, and investment forums to educate investors on the potential risks and rewards of investing in Zimbabwe.