The effects of economic vulnerability index indicators on exchange rates in developing countries: 1998-2022 panel data analysis application

After the 2008 Global Financial Crisis, in order to anticipate crises and take precautions, the US Federal Reserve (FED) started to express the economic vulnerability index as a measurement tool for high-risk countries in the Monetary Policy Report published in February 2014. This concept refers to an index comprising six key indicators that take into account the relative degree of fragility among Emerging Market Economies (EMEs) and the change in EME currencies against the dollar as a measure of financial market stress. Many EMEs have made serious efforts to reduce their vulnerability to external financing shocks in the aftermath of the crises. The aim of this study is to analyse the macroeconomic variables in the economic vulnerability index that affect the exchange rate for developing countries and to what extent they affect the exchange rate and to make policy recommendations. For this purpose, a panel data analysis was conducted using the data of 16 developing/emerging countries between 1998 and 2022. The analyses are performed with the Common Collinear Effects Mean Group (CCEMG) estimator. As a result of the analyses, it is found that there is a negative and statistically significant relationship between the Real Effective Exchange Rate (REER) and the External Debt / Total Exports Ratio, Inflation and Gross Public Debt / GDP Ratio. In addition, the relationship between the Real Effective Exchange Rate (REER) and the Current Account Deficit/GDP Ratio and the Private Sector Credit Debt/GDP Ratio is negative, while the relationship with the Growth Rate is positive but insignificant. An increase in the ratio of external debt to total exports, inflation and the ratio of gross public debt to GDP causes a decrease in the real effective exchange rate, while changes in growth, the ratio of current account deficit to GDP and the ratio of private sector credit debt to GDP do not have a significant effect on the real effective exchange rate.