Real exchange rate, FDI and foreign trade linkages

The abundance of theoretical models and empirical studies have analysed the possible links between foreign direct investment (FDI) and real exchange rate (RER), and between Exports and RER. It is, however, surprising that there was little empirical work investigating the relationships among exports, FDI and RER at once. The aim of this paper, therefore, attempts to fill the gap by econometrically testing for the linkages among these three in a co-integration framework, which is based on the East Asia - Vietnam trade relationship for the period 1990 - 2007. Our major finding provides an evidence of a number of statistically signifiant linkages. First, a real depreciation of Vietnam dong with respect to the foreign currency increases both FDI into Vietnam and trade flows from Vietnam to five Eastern Asian countries. Second, we observe: (i) a strong causality between FDI into Vietnam and the Vietnam imports from the FDI home country but (ii) a weakly causal linkage between FDI into Vietnam and the Vietnam exports to the FDI home country. This result suggests an open issue, which concerns the role of the performance of FDI flows into Vietnam from a specific Eastern Asian country in promoting the Vietnam exports to other Eastern Asian countries through cross-country spillovers channel. Third, these sets of relationships are consistent with the previous studies that support two ways through which the RER can affect trade flows: a direct effect on the relative price of goods and an indirect effect via FDJ channel.