Exchange Rate Policies In Developing Countries

The financial stand in in virtually growing countries is unstable due to the senior high school level of puffiness and lame currencies. The fiscal indemnity of a sylvan usually is affected by its financial flip-flop prescribe. A coarse provoke attempt to engage on a reductive or expansionary pecuniary indemnity depending on the nub of silver that is actually in circulation. A plain with to a greater extent come up of money in circulation with increasing puffinessary respect tends to train a reductive monetary constitution where bank interest range is change magnitude and expenditure on metropolis infra geomorphological goods is limited.On the other hand, an expansionary monetary policy encourages the growing in money supply to the parsimoniousness by reducing interest and bank lending drift, and engaging more in capital expenditures. No matter the monetary policy embarked on by a establishment, this goes to wreak the monetary qualify point of muc h(prenominal) demesne. According to Svensson (2000) the signifi endurece of swap dictate on a soils monetary policy lies in the addendumal channel that supercede respect provides for the transmission of monetary policy.Secondly, the supersede measure involve a forward looking protean in which case it provides valuable information in the designing and execution of monetary policy. Thirdly, monetary policy is enhanced through foreign shocks that argon mainly propagated thoroughly in transpose enjoin. A country can utilize either a rooted(p) monetary re-sentencing rate or a fictile deepen rate, depending on the supply rate of money and the monetary independence it choose to stick with.In a ontogenesis country, with bleached institutions, the swop rates of such countries ar determined by relaying in comparative measure with currencies from other strong and stable economies. Thus, it is laborious for these growth countries to scarper whippy give-and-take rates. As a malleable supervene upon rate requires that solid financial structure is laid, and merge, fiscal and monetary policy institutions ar in place.Developing countries engages in resolved rate to operate its shift rate. In direct, a firm rate for monetary throw entails that the countrys central financial institution, i. . the Central Bank spoil and sell the domesticated cash at a given rate. Furthermore, the viability of such monetary operation is entirely tied to the countrys level of world(pre token(a)) reserves held by its authorities. ECONOMICS INDEXES ASSOCIATED WITH A DEVELOPING COUNTRIES just about develop countries ar consumers society with little production. Most revenue and room for generating foreign commutation for this category of country are on prime goods in form of exploration of natural resources and agricultural activities.Agrarian economies and exploration of base products are mainly source for generating foreign transfigure in exploitation countries. In other words, the economies of most ontogenesis countries are tied smoothen to the apron strings of advanced economies. Electronics, technological products, consumable products and finished goods are the main items of import for growing countries. The costs for importing these finished goods are more costly when compared with the amounts that are paid for exports of primary goods and raw materials from ontogeny countries.The inequalities in the pricing organisation in the international market place are unfavorable for development countries. This variable contributes to the foreign reserves of ontogeny countries. Invariably, it affects the determine of specie and its exchange rate. The monetary nurses of ontogeny countries are weak when compared with those of spirited economies. Inflation affects the economicalal growth and development of evolution countries. In a office where there is much money in the economy pursuing little goods in the economy, thi s situation leads to increase in inflation rate.Inflation numbers the purchasing reason of people in a given economy. This weakens the value and use of money as a medium of exchange (especially in a galloping inflationary situation). To Ogbokor (2004), Inflation, in a developing country, encourages inventory solicitation in the form of raw material, excessive investment in intersection building and landed property. As a result, capital is prevented from being utilized for projects required for economic growth.The logical implication of information in developing countries is that there brings about dearth of infrastructural amenities and the reduction of purchasing power of people for embracing a meaningful living. Financial institutions in developing countries, such as in Africa, are highly underdeveloped culminating in lack of depth financial consolidation, extensive inefficiency and over populated urban areas. The stock exchange markets in African countries are still in their embryonic state. They are just beginning to gain ground.In new-fangled times, the Nigerian Stock exchange market (NSE) is making progressive growth in capitalization and growth in stock indexes. The growth in the Nigerian market especially in 2007 financial operation year in the public reform policy taken in the countrys financial sector has aided the stock exchange market in the country. In 2005, the consolidation of the Nigerian banking sector through the recapitalization has brought great cash advance in the banking sector and financial institution (Njoku, 2006).The great feet attained in the reform, policy has led the politics to introduce this recapitalization policy in the redress sector. In the past the Breton institution, such as the International Monetary farm animal (IMF) and the World Bank have recommended several medicines for the ailing economies of third orb and developing economies. Such measures to embark on a structural limiting programmed that result invo lve the devaluation of their currencies, among other measures such as privatization of public enterprises, removal of subsidies on public goods and less government intervention in their countries economies inter-alia.Even though these developing countries have put the structural programmed into use there situation economically still remain the same, sometimes made whisk. This SAP-induced inflation has resulted in adverse income redistribution, leading to increased individualised insecurity and lessened personal satisfaction, while heightening interpersonal and institutional tensions and deterring investment and inhibiting consumer spending (Anyanwu 1992). fiscal EXCHANGE POLICIES IN DEVELOPING COUNTRIES The move to find an appropriate policy for monetary rate for developing countries has being on for decades now.But the quicksilver(a) capital situation in these category of countries have made it more contend for finding a lasting settlement for the monetary exchange these cou ntries. In these view, Velasco (2000) argued, a pregnant conclusion that is shared from the volatile monetary exchange rate from developing countries is that adjustable or crawling pegs are passing fragile in a domain of volatile capital movements. The stuff resulting from massive capital flow reversals and weakened domestic financial systems was excessively strong even for countries that followed sound macroeconomic policies and had life-sized stocks of reserves.Since the 1970s, the volatile nature of the exchange rate of poor and developing countries is seen to be permeant as there are no stable, developed and consolidated financial institutions to peg exchange rate for countries and partners that these developing countries transact international business. The invade here according to Collins (1995) was that the market for the developing countries money were so thin, creating a volatile exchange rate that would be disruptive for economic activity.The missing link for deve loping countries for a lasting solution for its exchange rate has being on the lack of a consolidated financial institution and stable economy. This situation for developing countries is made worst during the 1970s and 80s. Prior to the 1980s, it was widely believed that operating a competitive rudderless exchange rate regime required a level of institutional development that developing countries did not possess (Quirk, 1994 135). The volatile nature of the exchange rate as recognized in the economy of developing countries is not entirely an inherent cause sometimes the activities of foreign and developed economies.For instance, the event of the European currency bloc has aided in rendering the exchange rate more volatile in developing countries. This according to Collingnon (1999) cited in Kawai & Takagi (2003) has made exchange rates surrounded by the three major world currencies more volatile and thereby contributed to the reduction of cross-b differentiate investment worldwid e. The economic structures in developing countries in term of its embryonic and underdeveloped financial institutions are contributory factors that are making them have an unstable and atypical monetary exchange policy.The explanation for the long run inflationary stylus in developing nations, according to the Structuralists, is in terms of certain structural rigidities. These include market imperfections and social tensions in those nations, including the relative inelasticity of the food supply, foreign-exchange constraints, cautionary measures, a rise in the demand for food, a fall in export earnings, hoarding, import substitution, industrialization, and semipolitical in constancy, inter-alia (Ghatak 1995).The devaluation of currency of developing country is make with the aim to create a real basis for measuring workable and accurate exchange rate amongst imports and exports of transactions in the international market. However, the usefulness of real devaluation in stimulat ing growth may await self-evident this view is not uniformly supported either by prior theoretical research or by the experience of countries implementing exchange rate devaluations (Kamin & Rogers 1997). Devaluation of currency of developing countries have it untold hardship and high cost for goods and services.Looking at the devaluation of the Nigerian currency, Anyanwu (1992) argues, the continued naira depreciation has encouraged the export out of goods (especially food stuffs) leading to local anaesthetic scarcity and higher prices. It has similarly encouraged a brain drain, partly in an attempt to describe the benefits of naira depreciation, the remittances from which are mainly used for consumption activities, again aggravating local prices. THE SIGNIFICANCE OF A FIXED EXCHANGE RATE FOR DEVELOPING COUNTRIESIn recent times, some scholars have conducted research to analysis the use of a glacial exchange rate as basis for structuring the exchange rate regime in developing countries. Probity analysis is used to study the determinants of exchange rate regime, build their empirical models around a framework in which the political cost associated with devaluation under fixed exchange rates plays a major role (Frieden et al 2000). In a fixed exchange rate regime, the government of the developing country directly set the noun phrase exchange rate.Given the constraints and undeveloped financial institutions in developing countries, the practice of a fixed monetary exchange rate for developing countries is made sticky. The reinforcement of engaging a fixed exchange rate is to help stimulate a countrys economy. This is aimed at bringing structural change that would integrate the countrys economy into the world economy order in the quickest time possible. This has made currency board of most developing countries to take the move of attaining a fixed exchange rate as a priority that should be attain (Mart, 2004).Before the fall of the Bretton woodwind syst em in 1973, m either countries including many Latin American developing countries had adopted a fixed exchange rate regime. The reason for adopting this exchange rate regime measure is to keep in line inflation, reduce exchange rate volatility or to improve competitiveness (Frieden et al 2000). In addition a fixed exchange rate regime tend to modify government of developing countries be counterbalanced in that they cannot fix any fiscal rate that would be excessive to cause the end or currency collapse.Fixed exchange rate sometimes is used as a short term corrective to harness a developing countrys monetary policy and help it gain credibility. For some developing countries like Poland, Mexico and Vietnam in the 1990s, the fixed exchange rate was utilized as a temporary measure to re-establish these countries policies to gain credibility (Ohno, 1998). Thus, a fixed exchange rate is acceptable in certain circumstances for developing countries, especially where there are unexpected real and financial shocks.However, this should not be permanently used as a measure for operating a developing countries monetary exchange. The flexibility exchange rate is more adequate for revamping the ailing and volatile exchange rate of developing countries. In an unstable world economy, they must retain the ability to combine stability and flexibility as circumstances change. For the same reason, currency boards and permanently fixed exchange rates (with no escape clause) are not to be recommended (ibid).In a galloping inflationary situation in a developing country, the exchange rate policy to adopt is a waxy one that allows currency to float and depreciate. After the tightening of the macroeconomic policies in such a country, it becomes useful to adopt a fixed exchange rate as a measure. As Ohno (1998) puts it, As inflation subsides to a more tractable level (say, 10 to 20 percent per year), the fixed exchange rate becomes a symbol of monetary and fiscal prudence and its ab andonment becomes politically too costly.Invariably, it means that the utilization of a fixed exchange rate should come in when the inflationary rate of a developing country is becoming low and at a manageable level. Furthermore, the utilizing of a fixed exchange regime in developing country is significant in the sentiency that it provides stability of price to local economic agents. This is especially in the case where a country operates an open economy, in which exchange rate volatility may have substantial costs indoors itself (Frieden et al 2000). As earlier stated a country has the plectron either to choose a fixed monetary exchange rate or one that is supple.For developing and emerging economies that want to choose a policy of a permanently fixed exchange rate this can be done through its currency board with it could adopt a common currency (Dollarisation). On the other hand, developing countries can adopt a flexible policy, which according to Taylor (2000) is the only sou nd monetary policy is one based on the trinity of a flexible exchange rate, an inflation target, and a monetary policy rule. However, the benefits and the cost implication of fixed exchange rates depend on the country and those variables and characteristics it is associated.For instance, a country with exceedingly high level of inflation with the urgently take away to stabilize its economy will be beneficial to utilize a fixed exchange rate. The higher the rate of inflation i. e. one on a lower floor some hyperinflationary threshold, the more a fixed rate will inspect competitive pressures on tradable producers and more broadly pressure on the equilibrate of payments (Frieden et al 2000). According to Collins (1995), a government of developing country should opt for a fixed exchange rate regime when it sense and anticipate a small misalignment cost from maintaining the existing peg.In addition, the need for government to adopt a fixed exchange rate is when she believes that disc rete nominal exchange rate registrations have only small political costs, when the government perceived her ability to manage a flexible exchange rate as low, or when the government attempt to stabilize a actually high inflation. Third world countries usually are faced with political instability. During period of political instability, the adopting of fixed exchange rate by a developing country is more pronounced (Frieden et al 2000).The drawback associated with a fixed exchange regime for developing country is that an inflation differential between the pegging country and the anchor generates an appreciation of the real exchange rate, which in the absence of compensating productivity gains, hurts the tradable sector and might generate a balance of payments crisis (ibid) THE posit TO ADOPT A FLEXIBLE EXCHANGE RATE FOR DEVELOPING COUNTRIES For a country adopting a flexible exchange rate, the government of such country has imperfect control over the nominal exchange rate in its mo netary policy.In this case, the actual exchange rate is influenced by some shocks twain at home and abroad The greater the variance of these shocks the less control policy makers will have over the actual nominal exchange rate (Collins, 1995). The right situation for a government of a developing state to adopt a flexible includes when it perceives and anticipate a large misalignment costs from maintaining a pegged rate, when the political costs to discrete nominal adjustments are high flexibility exchange rate is conducive in such situation.Furthermore, when the government believes her ability to manage a flexible rate was high, and when the government of the state is not planning to stabilize very high inflation (ibid). In the same vain Velasco (2000), argues, If shocks to the goods markets are more prevalent than shocks to the money market, then a flexible exchange rate is preferable to a fixed rate for developing countries.On the other hand, when every movement in the nominal ex change rate is quickly reflected in an upward adjustment in domestic prices, then the insulation provided by flexible exchange rates is nil and thence not expected to provide a satisfactory exchange rate regime (ibid). Under a flexible exchange rate, the change in relative price quickly takes place, strange the situation in fixed exchange rate where it changes slowly. Thus, there is avail for developing borrowing under a flexible exchange rate.A flexible exchange rate gives borrowers an incentive to hedge that may be abstracted under more rigid regimes (Velasco 2000). With the advantage that accomplish flexible exchange rate, it is still expected that each developing countries should choose and adapt to its accept exchange rate system with respect to common basket. Whatever the noble arrangement that is adapted be it a flexible exchange rate regime or a managed float, the important point is that each country in the region should stabilize the real effective exchange rate at no rmal times by targeting a common currency basket (Kawai &Takagi 2003).The need for developing countries to adopt a flexible exchange rate is more on the volatile nature of the countries with weak financial institutions. The negative effect of exchange rate volatility for developing countries on trade is more obvious when compared to those of developed economies. Taking on parity between the difference in exchange rate volatility between developing countries and developing countries, it is seen that work on Pakistans exports to Germany, Japan, and the United States for 1974-85 suggests that exports were importantly adversely affected by disagreement in nominal two-sided exchange rates.On the other hand, the effect of real exchange rate variability on the exports of Chile, Colombia, Peru, the Philippines, Thailand and Turkey have attained the clear evidence of generally considerably negative and substantial impact (ibid). Scholars have advocated more of flexible exchange rate for d eveloping countries than a fixed one, however there are demerits associated with the use of flexible exchange rate. According to Collins (1995), flexible exchange rates make it very difficult to alter domestic price and wage setting behavior so as to reduce inflation.More flexible exchange rate regimes may result in higher equilibrium levels of inflation because they do not effectively discipline central bankers (ibid). CONCLUSION The monetary exchange rate of developing is characterized by a highly volatile and unstable exchange rate regime. Thus, it becomes difficult to adopt a fixed exchange rate regime, given the weak financial institutions in this category of countries. Furthermore, the embryonic state of capital market and other financial institutions in developing country further weakens the currency of these countries.Inflationary rate in developing countries are on the increase thus to stable the economy within shorter period, anticipating a short misalignment costs will be adequate for a government of a developing country to adopt a fixed exchange rate. On the hand to correct, a flexible exchange rate regime is suitable for a developing country in managing its economy currency stability over a longer period. The development of financial institutions and the consolidation of capital and money markets of developing country will aid them to embrace a feasible regime that would contribute to strengthen its currency value and ensure a vibrant economy.