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Exchange rate volatility and its impact on borrowing costs

Author

Listed:
  • 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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    References listed on IDEAS

    as
    1. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(1), pages 139-161.
    2. Ashima Goyal, 2018. "Evaluating India’s exchange rate regime under global shocks," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 11(3), pages 304-321, September.
    3. C. Emre Alper & Oya Pinar Ardic & Salih Fendoglu, 2009. "The Economics Of The Uncovered Interest Parity Condition For Emerging Markets," Journal of Economic Surveys, Wiley Blackwell, vol. 23(1), pages 115-138, February.
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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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