Nexus among Exchange Rate Volatility, Inflation, and Economic Growth: A Panel Data Analysis

Abstract

This study undertakes an examination of the intricate relationships among exchange rate fluctuations, inflation, and economic growth within South Asian nations, namely Pakistan, India, Bangladesh, Sri Lanka, and Nepal. Spanning the temporal horizon from 1990 to 2021, the research endeavors to unveil the repercussions of exchange rate instability on economic growth—a formidable challenge confronted by monetary authorities and policymakers in South Asia. The central focus lies on comprehending the dynamics of exchange rate volatility, inflationary pressures, and their collective impact on economic growth. In the pursuit of these objectives, GDP per capita serves as the yardstick for economic growth, while independent variables encompass a spectrum including broad money supply, exchange rate volatility, inflation, government consumption expenditures, and gross fixed capital formation. The quantification of exchange rate volatility entails the utilization of both the standard deviation and the GARCH (1,1) models. Subsequent to an in-depth analysis, the initial unit test results undergo reevaluation, incorporating the Breusch-Pagan LM, Pesaran CD, and Pesaran scaled LM tests to discern cross-sectional dependence. To address potential data non-stationarity while considering cross-sectional dependence, the Pesaran-CIPS and Pesaran's CADF tests are applied. A pivotal aspect of the research involves the application of a Feasibly Generalized Least Squares (FGLS) regression model. The outcomes of the FGLS panel data regression illuminate a noteworthy finding: exchange rate volatility, quantified through both techniques, significantly and adversely influences economic growth. In contrast, inflation exhibits a statistically insignificant negative impact on economic growth. The study culminates by proffering specific recommendations to policymakers, urging concerted efforts to ensure exchange rate stability and foster sustained economic growth.