Exchange rate pressure, fiscal redistribution and poverty in developing countries

Abstract

This article investigates the interplay between the exchange rate pressure (ERP), which is a proxy for export demand and foreign financial flows shocks, and fiscal redistribution in influencing poverty in developing countries. The analysis relies on an unbalanced panel dataset containing 90 developing countries over the period 1980–2014 and uses the two-step system GMM approach. Empirical results show that ERP influences positively poverty in developing countries, with the magnitude of this positive effect being the same for least developed countries (LDCs) and NonLDCs (countries not classified as LDCs in the sample). In addition, fiscal redistribution exerts a positive effect on poverty in developing countries, including in NonLDCs, but for LDCs, it leads to lower poverty rates. Interestingly, over the full sample, fiscal redistribution helps in reducing the magnitude of the positive effect of ERP on poverty. A further analysis has been performed by replacing ERP with a measure of terms-of-trade instability. Previous results are largely confirmed, with the exception that terms-of-trade instability exerts a higher positive effect on poverty in LDCs than in NonLDCs. Furthermore, while the positive poverty effect of terms-of-trade instability diminishes as the extent of fiscal redistribution rises, terms-of-trade instability leads to poverty reduction above a certain level of the extent of fiscal redistribution. Overall, these findings indicate that well-designed fiscal redistributive measures could help governments mitigate the adverse effects of external economic and financial shocks on poverty in developing countries.