Academic journal article Indian Journal of Economics and Business

Exchange Rates Misalignment in Asian Emerging Economies

Academic journal article Indian Journal of Economics and Business

Exchange Rates Misalignment in Asian Emerging Economies

Article excerpt

I. INTRODUCTION

The emerging economies experienced major instability of currencies and real exchange rates (RER) fluctuations. Globalization also caused significant economic transformation characterized by progressive liberalization of capital flows and currency convertibility. The estimate of misalignment as a significant deviation of the actual RER from its equilibrium level requires the determination of a reference level or an equilibrium RER. It is important to determine the "good" value of exchange rate that measures the episodes of under or over- valuation of currencies.

The financial architecture characterized by the International Financial Integration (IFI) renewed the interest of studies on RER variability. In spite of its advantage of financing the development of emerging economies, this new financial context amplified their vulnerability to some types of shocks, notably in terms of balance of payments and exchange market (Reinhart and Smith, 2001 and Corden, 2002). Some authors suggest that the financial openness affects the frequency of volatility (Aguirre and Calderon, 2006, Amor and Sarkar, 2008). This new financial architecture also allows an increase of the consumption efficiency, the financial market liquidity, and the diversification of risk (Le Fort, 2005).

Some studies indicate that an overvaluation is not favorable for producing tradable goods and services (Edwards et al. 1999 and Sekkat and Varoudakis, 2002) and sometimes it leads to monetary crisis (Frankel and Rose, 1996; Kaminsky and Reinhart, 1999). There are also studies that claim a positive relationship between the RER variability (depreciation or undervaluation) and an improvement of economic performances, stimulation of growth (Domac and Shabsingh, 1999), and increase in exports (Dooley et al. 2003). However, an excessive overvaluation tends to slow down growth and undervaluation tends to accelerate it (Aguirre and Calderon, 2006). There does not seem to be a linear relationship between RER misalignment and economic growth.

The main objective of our study is to address the following questions: In which measure does the IFI affect equilibrium RER levels? What is the effect of RER variability on economic growth of emerging economies? Is the relationship between RER distortion and growth non-linear?

Due to significant international financial integration (IFI) in the region, we focus on South and South East Asia (SSEA). We attempt to present a concise review of the controversies of the effect of IFI on equilibrium RER level and RER misalignment and economic growth. We synthesize a model for the determination of long run RER in the context of IFI and specify another model for RER and economic growth.

We analyze data of a panel of eight countries of the SSEA region for 1979-2004 by using the recent developments of econometrics of dynamic panel. The addition of an individual dimension to a temporal one represents a great interest for the analysis of non-stationary series. Indeed, the tests of unit root and cointegration panel of Pedroni (2004) on panel data are more powerful than their analogous ones on individual temporal series in a small sample. We note Baltagi and Kao (2000) for non-stationary panel data that aims to combine <

II. EXCHANGE RATE MISALIGNMENT, IF I AND MISALIGNMENT

With the integration of the majority of emerging economies in a process of international financial and commercial liberalization, recent literature pays considerable attention to the Equilibrium Real Exchange Rate (ERER) and RER misalignment. …

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