Exchange Rates and Japanese Direct Investment in China

This paper analyzes FDI and exchange rate nexus in the context of Japanese direct investment in China. Using the data of Japanese direct investment in China’s nine manufacturing sectors from 1981 to 2001, the paper found that, there exists a significantly positive correlation between the bilateral real exchange rate of yen to yuan and Japanese direct investment in China. Specifically, the appreciation of yen significantly stimulated the inflows of Japanese direct investment while the depreciation of yen leading to a decrease of Japanese FDI. As the sharp devaluation of yuan against yen in the period under consideration is attributed to China’s deliberate devaluations on yuan in early 1990s and pegging yuan to US dollar policy, China’s exchange rate regime played critical role in strengthening China’s competitiveness in attracting export-oriented FDI. The exchange rate regime should be credited for the surge of FDI inflows in China.