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Exchange rate volatility and its impact on borrowing costs

Author

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  • Ashima Goyal

    (Indira Gandhi Institute of Development Research)

  • Sritama Ray

    (Indira Gandhi Institute of Development Research)

Abstract

Reducing borrowing costs for emerging markets (EMs) is a challenge. The additional country risk premia that foreign investors seek are primarily driven by a fear of unexpected currency depreciation; which often does not take place. It follows there are positive excess returns from EM assets. We find while the interest rate differential (IRD) is near-zero for advanced economies, it is always positive for EMs. Excess exchange rate volatility is often due to global and not domestic factors, so that a pure float aggravates instead of mitigating shocks. Lower exchange rate volatility, risk and risk-perceptions can reduce EM IRDs. A suitable exchange rate regime and domestic as well as international prudential regulation on cross-border capital flows can lower volatility. Different phases of India's flexible float illustrate these issues well.

Suggested Citation

  • Ashima Goyal & Sritama Ray, 2025. "Exchange rate volatility and its impact on borrowing costs," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2025-026, Indira Gandhi Institute of Development Research, Mumbai, India.
    • Handle: RePEc:ind:igiwpp:2025-026
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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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