Impact of Capital Inflows on Exchange Rate in Developing Economies: A Panel Data Analysis

Authors

  • Muhammad Ejaz Ph.D. Scholar, The Islamia University of Bahawalpur, Pakistan.
  • Ali Azam Associate Professor of Economics, Department of Economics, The Islamia University of Bahawalpur, Pakistan.

DOI:

https://doi.org/10.5281/zenodo.10512954

Keywords:

Exchange Rate, Capital Inflows, Foreign Direct Investment, Foreign Portfolio Investment, Foreign Remittances

Abstract

Purpose: This study examines the impact of capital flows on exchange rates in developing countries using a panel data set of 82 countries covering the period 2001-2020.
Design/Methodology/Approach: The Generalized Method of Moments (GMM) is used to address the endogeneity problems inherent in the data in the empirical analysis.
Findings: The results show a positive and significant effect of capital inflows on exchange rates and indicate that an increase in capital inflows is associated with a strengthening of a country's currency. This finding aligns with previous studies, reinforcing the relevance of capital inflows in shaping currency values. Additionally, the study reveals a significant negative impact of inflation on exchange rates, emphasizing that rising inflation tends to devalue a country's currency. Moreover, industrial value indicates that economic growth and increased industrial output contribute to a stronger currency. Control variables such as GDP, real interest rate, tourism, and trade also exhibit expected relationships with exchange rates, corroborating existing literature.
Contribution/ Originality: The distinctive aspect of this research lies in the computation of a foreign capital inflows index through principal component analysis. Influence of capital inflows and control variables hold crucial significance for policy considerations in domains such as domestic demand management and exchange rate regulation.

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Published

2024-01-15

How to Cite

Ejaz, M. ., & Azam, A. (2024). Impact of Capital Inflows on Exchange Rate in Developing Economies: A Panel Data Analysis . Pakistan Journal of Social Sciences, 44(1), 41-52. https://doi.org/10.5281/zenodo.10512954