Domestic Currency Research Articles

Business cycles in emerging markets: The role of liability dollarization and valuation effects

Understanding differences in business cycle phenomena between Emerging Market Economies (EMEs) and industrialized countries has been at the center of recent research on macroeconomic fluctuations. We investigate whether these are linked to credit market imperfections. To this end, we develop a small open economy Dynamic Stochastic General Equilibrium (DSGE) framework featuring both permanent and transitory productivity shocks, endogenous exchange rate movements, and liability dollarization and valuation affects, thereby accounting for the fact that emerging markets are facing difficulties in borrowing in domestic currency on international capital markets. We estimate our model using Bayesian techniques for several EMEs, thereby controlling for potential heterogeneity across countries. Our main findings regarding EMEs’ business cycles are (i) despite financial frictions, trend shocks are the main determinant of macroeconomic fluctuations, (ii) accounting for liability dollarization ameliorates the model fit, and (iii) valuation effects on average stabilize changes in the net foreign asset position.

Nonlinear Interactions and Volatility Spillovers between Stock and Foreign Exchange Markets: The STVEC-STGARCH-DCC Approach

This study aims to investigate the interactions, volatility spillovers and smooth transition effects between stock and foreign exchange markets in emerging versus developed countries by the Smooth Transition Vector Error Correction-Smooth Transition GARCH with Dynamic Conditional Correlation model (STVE-STGARCH-DCC). The empirical results yield several findings. Firstly, boom stock markets in emerging countries will trigger their domestic currency appreciation, while prosperous stock markets in developed countries result in currency depreciation. Secondly, the conditional variances for stock markets mainly result from unexpected shocks, past volatility, and short-term impact effects, thus leading to a persistence of volatility in both emerging and developed markets. The conditional variances for foreign exchange markets display similar patterns but show weaker short-term impact effects and slower transition speeds. Thirdly, unexpected shocks in a stock market broadly affect its own stock volatility, while those only affect India’s volatility in the rupee market. In contrast, unexpected shocks in foreign exchange markets mainly affect foreign exchange volatility, except for India; however, those influence their stock volatility only for emerging countries, such as India and South Africa. Lastly, developed markets are more efficient than emerging markets are. JEL classification numbers: C32, C51, C52, G11, G15 Keywords: Asymmetric Effects, Bivariate STVEC-STGARCH-DCC, Market Efficiency, Nonlinear Model, Smooth Transition Auto-regression, ICSS Algorithm.

The Capital Flow Volatility Spillover in Some Selected African Economies

Purpose: The study conducted an empirical examination of the link between capital flows and exchange rate by examining the relative influence of FDI and FPI on the exchange rates. 
 Method: The study proceeded with the EGARCH model and the data sample covering the period from 1990-2016. The data were subjected to cross-country screening. The screening criteria are such that all the data that constitute capital in all sampled countries must have equal sample sizes. The measurement of capital flow in each of the sampled countries was restricted to two categories capital, namely, foreign portfolio investment (FPI) and foreign direct investment (FDI).
 Results: The research establishes that the behavior of capital flow volatility spillover of the sample countries' currencies exchange rate differs, with only South Africa's and Morocco's currencies revealing some slight similarity and existence of asymmetric volatility spillover from capital flows to exchange rate. Additionally, the study discloses that capital flows spillover has a considerable effect on exchange rate volatility than harmful spillover. The study also observed that positive shocks associated with capital flow volatility affect exchange rate value in Botswana more than capital outflow. Further positive capital flow spillover impending from capital inflow has a considerable effect on exchange rate volatility than the harmful spillover impending from the capital outflow. Further, the positive capital flow spill over impending from capital inflow significantly affects exchange rate volatility more than the negative spillovers that emanate from the capital outflow. 
 Implications: This suggests that the monetary policy should consider options that can accelerate capital flow into the Moroccan economy. However, in South Africa for any given quantum of capital flow into the economy, the South African Reserve Bank must use instruments to affect stability; otherwise, the currency exchange rate could remain unstable. Thus, capital withdrawals out of the Egyptian economy will create domestic currency instability.
 
 
 
 Keywords: Spill-over, Foreign Direct Investments (FDI), Portfolio Investments (PI), asymmetric, capital flow volatility, Exchange rate volatility.

Remittance and Dutch Disease Phenomenon: Case of Bangladesh and Pakistan

The paper has been designed to explore whether the impact of remittance on the real exchange rate causes any Dutch disease problem for Bangladesh and Pakistan. These two South Asian countries have been targeted to figure out if the outcomes are similar for the countries with almost the same economic structure. Johansen co-integration approach, Vector Error Correction Method (VECM), and Granger Causality test have been employed taking real exchange rate as regressand and remittance and other attributing variables as explanatory variables with an aim to address the study objective. The study has used data from the World Development Indicators database ranging from 1986 to 2019. The results for both countries reveal that remittance is significantly negatively related to the real exchange rate which implying the appreciation of the domestic currency. However, this appreciation causes the Dutch disease phenomenon for neither Bangladesh nor Pakistan.

Access to finance and the exchange rate elasticity of exports

The recent empirical literature estimating the elasticity of exports to exchange rate fluctuations has shown that, while devaluations have in general a positive effect on exports, the size of it varies significantly depending on firm-specific characteristics. Using Chinese firm-level data, we show that exporting activities by more financially constrained firms are more sensitive to exchange rate changes than those by firms with a better ability to raise external capital. This finding is detected at both the intensive and extensive margin of exports. Consistent with the result on export volumes, we also document that the exchange rate pass-through to export prices denominated in the domestic currency is lower for firms facing stronger financial constraints. Moreover, we establish that the role of financial conditions in determining a differential effect of exchange rate on exports continues to be relevant when we allow for a variety of alternative features that may also affect the firm-level elasticity of exports to exchange rate. These are the intensity of use of imported inputs, labor productivity, the degree of price stickiness and firm size.

The Influence of US Dollar Funding Conditions on Asian Financial Markets

More than 20 years after the Asian financial crisis, the region’s continued high reliance on United States (US) dollar-denominated funding has significant implications for the transmission of global financial conditions to domestic financial and macroeconomic circumstances. Given limited domestic capital market-based financing solutions, a high reliance on funding denominated in US dollars renders countries vulnerable to changing global financial and liquidity conditions. Using a dynamic panel and a vector autoregression model to assess the exchange rate as a possible transmission channel, we find that changes in bilateral US dollar exchange rates can have a significant impact on sovereign credit risk. In particular, a depreciation of the domestic currency against the US dollar leads to a widening of the sovereign bond spread. This finding suggests a significant relationship between US dollar funding exposure, US dollar liquidity conditions, and domestic financial conditions in some emerging Asian economies, and thus highlights one source of structural vulnerability. Given that the magnitude of the effects varies across countries, policy makers need to monitor closely the interplay between the exchange rates and local financial market conditions with tailored prescriptions for domestic financial resilience.

Information processing on equity prices and exchange rate for cross-listed stocks

I propose a novel structural setting to investigate the dynamics of information processing on equity prices and the exchange rate for cross-listed stocks. Using high-frequency data on Brazilian cross-listed firms, I disentangle the effects on firm value of the exchange rate from the other determinants of a firm's cash flow. In general, the results suggest that the U.S. is faster than the home market and that there is a net positive relationship between the value of the domestic currency and the firm's value. This result is linked to the likely partially segmented market characteristic of the home market. Robustness checks confirm the results.

OECD ÜLKELERİNDE REEL DÖVİZ KURU HAREKETLERİNİN AÇIKLANMASINDA BALASSA-SAMUELSON ETKİSİ

According to Balassa-Samuelson hypothesis which explains real exchange rate movements by productivity differences between tradable and non-tradable sectors, an increase in the relative productivity of tradable sector leads to a real appreciation of domestic currency. In this study, we analyze whether the Balassa-Samuelson hypothesis is valid employing recent panel data tehniques for a panel data set covering 25 OECD countries and the period 1990-2016. To this aim, the effect of sectoral relative productivity on real exchange rate is examined employing panel data estimators considering country heterogeneity, dynamic behavior and cross-section dependency. Results of Pooled Mean Group estimations support the Balassa-Samuelson hypothesis for OECD countries. However, the effect of relative productivity on real exchange rate becomes statistically insignificant when we control the cross-section dependency that arises due to common global shocks by employing Cross-sectionally Augmented Panel ARDL estimator (Chudik and Pesaran, 2015). Consequently, Balassa-Samuelson hypothesis cannot be robustly supported for OECD countries.

Winners and losers from sovereign debt inflows

We study the effects of sovereign debt inflows on domestic firms. To do so, we exploit episodes of large sovereign debt inflows, which follow the announcements of the inclusion of six emerging countries into major sovereign debt indexes. We find that these events reduce government bond yields, appreciate the domestic currency, and have heterogeneous stock-market effects on domestic firms. Firms operating in tradable industries experience lower returns than firms in non-tradable industries. In addition, financial firms, government-related firms, and firms that rely more on external financing experience higher returns. The effect on financial and government-related firms is stronger in countries that display larger reductions in government bond yields. The effect on tradable firms is stronger in countries that display stronger appreciations. We provide a stylized model that rationalizes these results. Our findings shed novel light on the channels through which sovereign debt inflows affect firms in emerging countries.

Turning Natural Resource Curse Into What It Should Be – Means to National Prosperity

It is the irony of human nature, and indeed the incentive mechanism inherent in social institutions, that some societies less endowed by nature strive harder to improve their collective lot, and in many instances succeed in achieving their development objectives more frequently than their counterparts with more favorable allotments of natural resources. And if necessity is truly the mother of invention, then the sorry economic conditions of many resource-rich African nations may not be so ironic after all. When it comes to wasted wealth, and the problems that bedevil poor countries that are rich in natural resources, especially oil, there is plenty of blame to go around. Economists have long observed that such countries tend to do badly. In a study in 1995, Jeffrey Sachs, now of Columbia University in New York, showed that the resource-rich grow more slowly than other poor countries — even after such variables as initial per capita income and trade policies are taken into account. The usual explanation for this is “Dutch Disease”, named for the hardships that befell the Netherlands after it found North Sea gas. When a country strikes hydrocarbons, a sudden inflow of dollar-denominated revenues often leads to a sharp appreciation in the domestic currency. That tends to make non-oil sectors like agriculture and manufacturing less competitive on world markets, thus leaving oil to dominate the economy.

The Implication of Financial Derivable from Abroad on West African Monetary Zone’s ECO Currency

This study aims to determine the extent to which the West African Monetary Zone (WAMZ) can fulfill the Expost conditions for achieving convergence. This study, therefore, evaluates the pattern of shock symmetry and convergence in connection to WAMZ’s Pillar III policy strategy. Time series data sourced from the World Bank for the period covering 1970 to 2017 were utilized for this study. Two basic econometric tools such as Impulse Response Function (IRF) and the ADF convergence test were employed to determine whether WAMZ can achieve selected Macroeconomic Convergence Criteria (MCC) in the long-run. From the study, we found that WAMZ is not a full potential candidate for ECO Economic and Monetary Union (EMU) due to the inability of the available results to show overall shock asymmetry in the entire models studied. Also, the study found that WAMZ could attain convergence in its inflation targets, but could not attain convergence in its GDP targets. Thus the results imply that in the long-run, WAMZ does not practically possess the attribute to achieve its MCC. Hence, it is imperative that for the adoption of the ECO currency, WAMZ should design and implement a short-run adjustment method to manage country-wise shocks and implement structural buffers to guard the WAMZ economies against structural shocks. Hence, we recommend that ECO currency be a reserve currency managed by the West African Currency Board (WACB) while the EMU member maintains its domestic currency. WAMZ is basically a quasi EMU.

In lands of foreign currency credit, bank lending channels run through?

We study the impact of monetary policy on the supply of bank credit when bank lending is denominated in foreign currencies. Accessing a comprehensive supervisory dataset from Hungary, we find that the supply of bank credit in a foreign currency is less sensitive to changes in domestic monetary conditions than the equivalent supply in the domestic currency. Changes in foreign monetary conditions similarly affect bank lending more in the foreign than in the domestic currency. Hence when banks lend in multiple currencies the domestic bank lending channel is weakened and international bank lending channels become operational.

Explaining Trends and Factors Affecting Export Diversification in ASEAN and SAARC Regions: An Empirical Analysis

This paper examines the role played by country-specific factors in the determination of export product diversification process. To meet this objective, the paper begins by constructing a time series data for export diversification using the Herfindahl index. Then, it applies the fully modified OLS co-integration model to a panel of selected ASEAN and SAARC countries to find out the main determinants of export product diversification. Export diversification pattern shows that since the mid-1980s the ASEAN countries have continuously witnessed export diversification and the SAARC countries embarked on export diversification journey since the early 1990s. Analysis of the determinants suggests that foreign direct investment, domestic investment, competitiveness, real depreciation of domestic currency, financial sector development and institutional strength are significantly and positively related to export product diversification in both regions. These findings have important policy implications for the two regions. They call upon the policymakers for further diversification of exports, especially in the areas of their specialization that are vital for their smooth and sustained foreign exchange earnings as well as economic development. The study also recommends improving international competitive strength via improving business environment to achieve the goal of export product diversification.

Naira - Yuan Diplomacy: A Pathway for Unlocking Nigeria’s Manufacturing Sub-Sector Potentials

The fountain head for weighing one unit of a domestic currency in-terms of another within an international framework is rooted in the famous Gold Standard proposed by the Bretton Woods Institutions (BWIs). This brand of thought had since been practiced and experienced in numerous trade ties that Nigeria had had with China. Like other bilateral agreements, it sets to re-define and deepen the two countries’ economic space. Thus, this paper shed lights on Naira - Yuan Diplomacy as a Pathway for Unlocking Nigeria’s Manufacturing Sub-Sector Potentials.The manufacturing industries are engines of economic prosperity. Facilitation of job creation space and poverty reducing strategies are core values in manufacturing too. This paper conclusively presume that the exchange rate pass-through mechanism can transmit price increase and macroeconomic instability from China and supply shocks to the Nigerian economy (especially from manufactured products) when adequate provisions are not domestically taken. Furthermore, the Naira-Yuan diplomacy will increase imports from China thereby increase her foreign income since Nigeria will be spending more on Chinese manufactured products, hence, increase the national income of China. The policy implication of this finding is that the net exports of China will rise faster and add to her expansion of domestic income instead of Nigeria. The paper therefore calls upon Nigeria to be proactive in ensuring a stable trade and exchange rate policies to deepen technical innovation for local manufacturing tools to boost output rather than depending more on China.
 
 Received: 18 August 2020 / Accepted: 9 October 2020 / Published: 17 January 2021

Oil Prices, Exchange Rate Regime and the Russian Economy

Petrol ihracatçısı ülkelerde; petrol fiyatlarındaki beklenmedik artış, ihracat gelirlerinde önemli bir yükselişe neden olmaktadır. İhracat gelirlerindeki doğal kaynağa bağlı bu yükseliş ülkeye giren dövizi artırmakta ve yerel para birimin değerinde istenmeyen bir artışa neden olabilmektedir. Bu değerlenme ülkenin ekonomik performansını olumsuz etkileyebilmektedir. Bu çalışmanın amacı petrol fiyatlarındaki değişimin, Rusya’nın para ve maliye politikaları üzerine direk etkisi olduğu bilinen döviz kuru kanalının kontrol edilmesi varsayımı altında petrol fiyatlarındaki değişimin ekonomik performans üzerindeki etkilerini belirlemektir. Bu amaç doğrultusunda 1994-2018 yılları arası üçer aylık veriler ile Bernanke, Gertler ve Watson’un (1997) önerdiği modifiye Vektör Otoregresif model kullanılmaktadır. Yapılan analizler sonucunda, rublenin aşırı değer kazanması engellendiğinde; petrol fiyatlarındaki beklenmedik artışın faiz oranını dalgalı kurun benimsendiği durumdan daha fazla düşürdüğü görülmektedir. Fiyatlar ise, dalgalı kurun benimsendiği durumdan başlangıçta daha yüksek olsa da ilerleyen dönemlerde daha düşük fiyatlarla sonuçlanmaktadır.

Emerging Market Economy Exchange Rates and Local Currency Bond Markets Amid the COVID-19 Pandemic

Borrowing through domestic currency bonds has not insulated emerging market economies (EMEs) from the financial shock unleashed by Covid-19; EME local currency bond spreads spiked amid sharp currency depreciations and capital outflows.Portfolio investors face amplified losses as local currency spreads and exchange rates move in lockstep; their revised portfolio allocations in turn strengthen this correlation.EMEs with monetary policy frameworks that are equipped to address the feedback loop between exchange rate depreciation and capital outflows stand a better chance of weathering the financial fallout from the Covid-19 pandemic.To counter large stock adjustments in domestic bond markets, EME central banks may need to expand their toolkit to take on a "dealer of last resort" role; a number of them are already moving in this direction.

Cheaper currencies and long‐term growth: The effect of exchange rate management and capital controls

AbstractIn this paper, we test whether weakening the domestic currency can help boost economic growth. To estimate this policy‐relevant but yet complex link, we apply a new mediation analysis to isolate the long‐term growth effects of currency undervaluation induced by active exchange rate management and capital control policies. Using a dataset of 182 countries in the post‐Bretton‐Woods period, we find that changes in undervaluation driven by exchange rate management and capital control policies have no significant impact on long‐term growth. In addition, the direct growth effects of these policies are typically negative and offset the small positive impact gained indirectly through increased currency undervaluation.

Forecasting of Government Yield Curve in Post-Corona Pandemic

The Indonesia government conducts several fiscal strategies to solve Revenue and Expenditure Budget (APBN)’s deficit due to corona pandemic by relaxation of APBN’s deficit policy, using surplus balance, upsizing loan and bond in domestic and valas currency. Upsizing or issuance a new Indonesian bon called SUN, would increase cost of rate is paid by government and its maturity that impacted to yield curve and risk of SUN. It has inspired this research to (1) investigate the determinant of yield curve due to shocks that occur in Indonesian macroeconomic during the pandemic (2) the impact of the pandemic on SUN’s risk and (3) the forecast of the yield curve in SUN after the pandemic using the VAR / VECM method. The reasearch used secondary data of bond yield from Indonesian Stock Market and imposed the effect of such as inflation, BI Rate, Kurs and foreign exchange that is taken from several sources such as BPS, Central Bank of Indonesia and Bloomberg during 2015 January until 2020 May. This research proves that the five main macroeconomic indicators have an influence in the short and long term on the yield curve. YIELD, GDP and BIR variables have a significant negative effect in the short term on the yield curve, whereas CPI, KURS and CD have no significant effect. The ECT’s coefficient shows the speed of adjustment towards the long-term balance and the BI Rate adjustment is faster than other variables with an ECT coefficient of 0,33. The estimation results show that the average R-squared is above 55 percent with the highest value of 79,35 percent, this indicates that the equation was formed because the research variables amounted to the R-squared results.

Variance risk premium and expected currency return: the story is different at the tails of the distribution

ABSTRACT This paper investigates the prediction power of variance risk premium of domestic currency over the currency return for five major emerging market currencies controlling after the impact of past exchange rate developments and asymmetries in the variance risk premium, and the dependence between variance risk premium and currency return at different quantiles. The OLS regression results show that higher (lower) variance risk premium leads appreciation (depreciation) of domestic currency against US Dollar and this relationship holds in after controlling asymmetries in the variance risk premium and past currency returns. Besides, the results don’t confirm an asymmetric effect of the variance risk premium and a linearly increasing effect of variance risk premium conditional on different quantiles of past currency return. Finally, quantile-on-quantile regression (QQR) results show that the negative association of variance risk premium and currency return reverse to be positive at the tails.

The Impact of Monetary Conditions on Bank Lending to Households

We study the impact of monetary conditions on the supply of mortgage credit by banks to households. Using comprehensive credit register data from Hungary, we first establish a bank-lending-to-households channel by showing that monetary conditions affect the supply of mortgage credit in volume. We then study the impact of monetary conditions on the composition of mortgage credit along its currency denomination and borrower risk. We find that expansionary domestic monetary conditions increase the supply of mortgage credit to all households in the domestic currency and to risky households in the foreign currency. Because most households are unhedged, bank lending in multiple currencies may involve additional risk taking. Changes in foreign monetary conditions affect lending in the foreign currency more than in the domestic currency, and also differ in their compositional impact along firm risk.