Fiscal effects of exchange rate devaluation and capital flows to emerging countries

Abstract

In the assessment of governments’ fiscal performance, exchange rates play some roles while capital movements could serve as determinant of fiscal discipline. This study examined the effects of exchange rate devaluation, and capital inflows, on budgetary spending, and the interactions among the variables using the Bayesian vector autoregression (BVAR) and sys-generalized method of moments (GMM) estimators with 1,184 panel observations. The study covers 37 emerging nations. The variables had a co-integrating connection, demonstrating a long-run link between the variables studied. Having executed the Gibbs sampling for simulation efficiently, our Markov Chain Monte Carlo (MCMC) simulation converged appropriately. The sampling efficiency parameter is equal to 0.96257, close to 1. The Monte Carlo standard errors (MCSE) are extremely low at 0.000 with an implication of adequate precision in the BVAR model estimation. The results disclose that a 1 percent devaluation shock compressed fiscal spending by 0.56 percent and a shock to capital inflows stimulated 0.99% growth in fiscal spending. The 95 percent credible interval suggests a considerable size of effects on devaluation and capital flows. Accordingly, managing the exchange rate can be a valuable tool for managing capital shortage in Africa. Rather than increase government spending, governments should concentrate on revenue generation by utilizing an effective exchange rate policy to influence the national pattern of product diversification.