The relationship between exchange rate volatility and capital inflows in emerging markets: the role of financial development Online publication date: Fri, 31-May-2024
by Pham T.T. Trinh; Nguyen T.H. Vinh
Global Business and Economics Review (GBER), Vol. 30, No. 4, 2024
Abstract: This study investigates the role of financial development in the effect of exchange rate volatility on capital inflows. The threshold methodology and GMM estimation are employed to analyse the panel dataset of 20 emerging countries from 2010 to 2019. Two types of inflows are involved in the studies including foreign direct investment and portfolio investment to examine the responses of different inflows to exchange rate risk. Financial development is measured by two traditional indices including ratios of broad money to GDP and domestic credit to GDP. The results indicate a negative relationship between exchange rate volatility and capital inflows. However, financial development can reduce the detrimental influence of exchange rate volatility on capital inflows. This result suggests an improvement of financial development is necessary for diminishing the negative effect of exchange rate volatility. Emerging countries with low financial development should stabilise the exchange rate to attract more capital inflows.
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