Exchange Rate Volatility and Governance Indicators

Abstract

This study investigates the relationships between exchange rate volatility and governance indicators for emerging economies. Government effectiveness and regulatory quality as main indicators of governance are analyzed in terms of their implications for exchange rate volatility for a selected group of emerging countries consisting of Argentina, Mexico, South Africa and Turkey covering the period from 1996 to 2022. Government effectiveness indicator captures perceptions of the quality of public services, the quality of policy formation and implementation, the credibility of the government’s commitment to designed policies, the quality of the civil service and the degree of its independence from political pressures. Regulatory quality indicator measures perceptions of the ability of the government to formulate and implement sound policies and regulations that allow and promote private sector development. It is shown that countries with higher degrees of government effectiveness exhibit lower exchange rate volatility. In addition, higher levels of regulatory quality turn out to be associated with lower exchange rate volatility. These findings yield significant policy implications for emerging countries that experience high exchange rate volatility, which constitutes the major contribution of this study to the literature.