HOW ECONOMIC AND POLITICAL INSTABLITY AFFECT FOREIGN PORTFOLIO INVESTMENT FLOWS TO EMERGING MARKET ECONOMIES? DO FOREIGN EXCHANGE RESERVES MATTER?

Abstract

Foreign Portfolio investments are short term investment made by the portfolio investors and are highly sensitive to the developments and uncertainties that take place in a country and potentially causing economic or political instability. The study involves data of 16 emerging economies ranging from the time period 2010-2023. The study focuses on analysing the joint effect of both the instabilities on FPI inflows. The novel contribution of the work is analysing how foreign exchange reserves buffer the negative effect of instabilities on FPI flow. The methodology used is Driscoll-Kraay panel estimator, adjusting for the three issues that arise simultaneously, serial correlation, cross sectional dependence and heteroskedasticity. The main results reveal that economic instability significantly deteriorates FPI inflow in an emerging economy. However, political stability attracts portfolio investment as it builds investors’ confidence through quality governance and institutional working. The study further reveals countries with higher reserve dampen the negative effect of economic instability. The implications of these findings are relevant for policy of reserve management, macroeconomic stabilisation policy and strategy to build investor’s confidence to invest in a country’s assets.