Why is China so attractive for FDI? The role of exchange rates

This paper argues that China's exchange rate policy played a critical role in its FDI boom. Devaluation of the Yuan (Renminbi) and the policy of pegging the Yuan to the Dollar both improved China's competitiveness in attracting Foreign Direct Investment. Examining the hypothesis in the context of Japanese FDI for nine Chinese manufacturing sectors from 1981 to 2002, the empirical results show that the real exchange rate between the Yuan and Yen is one of the significant variables determining Japanese direct investment in China. The devaluation of the Yuan substantially enhanced inflows of direct investment from Japan, and the response of FDI to the change of the real exchange rate is elastic.