NO : WP-2025-026
AUTHOR : Ashima Goyal and Sritama Ray
TITLE : Exchange Rate Volatility and its Impact on Borrowing Costs
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.
Keywords: Exchange rate volatility; emerging markets; advanced economies; interest rate differentials; excess returns; global shocks; policies
JEL Code: F31, F41, E65
Weblink: http://www.igidr.ac.in/pdf/publication/WP-2025-026.pdf
