Disentangling the exchange rate risk, sectoral export flows and financial development nexus

This paper examines the differential responses of various emerging market export sectors to exchange rate risk. This paper finds origin in initial theoretical posits of Ethier (1973) and Clark (1973) which both contend that exchange rate risk has a negative impact on the export flows of international trade participants who are assumed to be inherently risk averse. Through panel data analysis (random effects, fixed effects and PDOLS models), this paper explores the effect that exchange rate risk exerts on emerging market exports –which have not enjoyed as much scrutiny as their developed country counterparts. For one, this paper examines how the ten major emerging market export sectors, of eleven countries, are impacted by exchange rate volatility (as an indicator of exchange rate risk). The general conclusion is that exchange rate risk (exchange rate volatility) does exert differential impacts on various export sectors. The fact that three of the four models which exhibit a statistically significant and negative exchange rate risk coefficient are differentiated product lines (Iron and steel; Machinery, nuclear reactors, boilers, etc; and Vehicles other than railway, tramway) does suggest that these product lines may be more susceptible to exchange rate risk when compared to homogeneous product lines. With regards to policy, it would be prudent on the part of emerging market policymakers to adopt macroeconomic policies which inspire stability so as to eliminate speculative attacks the domestic currency. In other words, emerging markets especially dependent on export revenue from the product lines in this paper which exhibited a significant negative response to exchange rate risk should provide support to these industries during periods of volatility.

Working paper 733
1 February 2018