Real exchange rate is positively significant only in
Real exchange rate is positively significant only in case of China and it has no effect on FPI volatility in case of remaining three countries. China is not trading in primary goods so fluctuation in exchange rate does not exist, so RER has significant positive effect on portfolio investment volatility (Bleaney & Greenaway, 2001.). Moreover, China is deliberately increasing its currency value and this factor has reduced return and causing the increase in volatility. The other possible explanation for no effect of exchange rate is the deduction of inflation rate from exchange rate; inflation may also affect exchange rate volatility according to interest parity theory which we have ignored due to multicolinearity problem.
In Pakistan and India, rise in interest rate increases portfolio investment volatility because higher inflation rate than interest rate reduces or declines the benefit of portfolio investment to foreigners and as a result, foreign investors are more likely to leave Pakistan and India. On the other hand, the insignificant values of RIR for China and Srilanka because these two countries have lower interest rate as compared to India and Pakistan; it has no effect on foreign portfolio investment. It diminishes the attraction of high interest rate for portfolio investors. Thus, the results are in accordance to Salahuddin and Islam (2008).
The interpretation of positive effect of Karachi stock index is that usually foreign portfolio investors assign (allocate) fix proportion of their portfolio investment in developing countries and this creates volatility in index leading to increase in market raises; investors sell their FPI investments to obtain short-term gains and when market falls, they start buying shares leading to short-term volatility in FPI (Gordon & Gupta, 2003). Another possible reason may be the higher volatility is due to sudden breakage in capital flows because investors rebalance their portfolios in context of wide opportunity set and breakage is associated to increase in net cash flows and it leads to order GSK-923295 in return on FPI on breakage (Bekaert & Harvey, 1998).
Conclusion and recommendations Foreign portfolio investment is of volatile nature and leaves the country due to uncertainty in macroeconomic factors. Based on our findings, we conclude that all the macroeconomic factors affect foreign portfolio investment volatility except interest rate in China. In India, inflation rate, foreign direct investment, interest rate and stock index bring significant volatility in foreign portfolio investment. Except exchange rate and inflation rate, all other variables have significant effect on FPI volatility in Pakistan. While only three variables, namely, economic growth, industrial growth and stock return bring significant variation in FPI in case of Srilanka. The inflation rate in India and China attracts more foreign investment and reduces portfolio investment volatility. These findings are consistent with Agarwal (1997) and Rai and Bhanumurthy (2004); they suggest that these two countries are managing and controlling their inflation. While inflation has no effect in Pakistan and Srilanka that confirm to Bleaney and Greenaway (2001) because exchange rate is being undervalued and currency of these two countries is continually falling and foreign portfolio investment persists (Lee & Yoon, 2007). FDI brings reduction in foreign portfolio investment volatility as is happening in China, India and Pakistan; it implies that in China, India and Pakistan the financial market is in progressing. However, in case of Srilanka, FDI is not playing its part to reduce FPI volatiltiy because of liquidity issues; investors hesitate to invest in portfolio investment because of less return. High economic growth rates attract more FPI and reduce volatility in FPI because high GDP growth rate will affect index to boost up then stock return would increase as the result leading to decrease in volatility of portfolio investment. Our findings in case of China are in accordance with the results of Bekaert and Harvey (1998). The economic growth does not affect FPI volatiltiy in India and Srilanka and this matches to Thapa and Poshakwale (2010) that portfolio investors are attracted by economic development that is captured by per capita GDP of the country.