The nexus between exchange rate and long-term investment in Indian manufacturing industry
ISSN: 2040-8269
Article publication date: 13 February 2019
Issue publication date: 13 February 2019
Abstract
Purpose
The purpose of this paper is to examine the impact of changes in the exchange rate on long-term investment decisions of Indian manufacturing firms at the sector level.
Design/methodology/approach
The study is undertaken on a sample of 1,222 firms from six key manufacturing sectors of Indian economy during the period 2000-2016. The non-linear relationship between real exchange rate and long-term investment is studied using the two-step generalized model of moments estimator.
Findings
The study finds a concave (i.e. inverted U-shaped) relationship between the long-term investment and real exchange rate, particularly in case of chemical, construction, machinery and textile sector, in particular, and Indian manufacturing industry as a whole. It implies that investments in these sectors increase with depreciation of real exchange rate up to a point of inflection and subsequent to which it starts decreasing if exchange rate continues to depreciate further. But consumer goods and metal product sectors ensure a convex pattern, which demonstrates that investment is decreasing at the initial stage of depreciation of the exchange rate. The study moves one-step forward in validating this nexus between investment and exchange rate with respect to the price-cost margin and the extent of financial flexibility of firms. It is found that high price cost margin and financial flexibility moderates the adverse impact of exchange rate depreciation and immunizes the long-term investments in the scenario of a weak domestic currency and induce long-term investments.
Research limitations/implications
The study measures the impact of exchange rate changes, but the impact of exchange rate volatility on investment has not been studied, which is absolutely different with different implications.
Practical implications
The study provides a clear guideline to firm managers for using the exchange rate movements in a favorable manner. The findings can be used to ensure sustainable long-term investments with respect to the core competence of firms in terms of price cost margin and financial flexibility at sector level of Indian manufacturing firms.
Originality/value
The study analyzes the non-linear relationship between exchange rate changes and long-term investment behavior of manufacturing firms from six key sectors of India. Further, the study moves one step forward to analyze this nexus under different scenarios of financial flexibility and price cost margin using dynamic panel models.
Keywords
Acknowledgements
The authors are grateful to the Editor, Prof. Lerong He, and the anonymous referees of the journal for their extremely useful comments and suggestions to improve the quality of the research paper. Usual disclaimers apply.
Citation
Panda, A.K. and Nanda, S. (2019), "The nexus between exchange rate and long-term investment in Indian manufacturing industry", Management Research Review, Vol. 42 No. 2, pp. 174-198. https://doi.org/10.1108/MRR-01-2018-0024
Publisher
:Emerald Publishing Limited
Copyright © 2019, Emerald Publishing Limited