Abstract

This paper analyzes the role of real exchange rate in determining Japanese FDI in China. Using the data of Japanese direct investment in China's nine major manufacturing sectors from 1989 to 2000, the paper conducts regression analysis with both time series and panel data. The empirical results show that there exists a significantly positive correlation between the bilateral real exchange rate and the inflows of Japanese direct investment to China. Specifically, the appreciation of Yen generally stimulated the inflows of Japanese direct investment while the depreciation of Yen leading to a decrease of the investment. To a large extent, the rise and fall of Japanese direct investment in China over the period is attributed to the fluctuations of the bilateral real exchange rate. As the sharp devaluation of Yuan in early 1990s was triggered by merging China's official exchange rate with market rates, the policy shift on the exchange rate regime should be credited for the surge of FDI inflows.