Impact of Weak Infrastructure on Exchange Rates in Emerging Markets

This article discusses the impact of weak infrastructure on exchange rates in emerging markets and the choice of appropriate exchange rate regime to maintain currency value. It highlights the risks associated with a volatile exchange rate and the importance of a stable economic structure for foreign investment. The article suggests a pseudo-flexible rate regime as a solution to keep the exchange rate free in the market but maintain enough stock of reserve to inject in the economy during volatile situations.

Running Head: INTERNATIONAL RELATION
International Relation
Name of the Student
Name of the University
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Table of Contents
Introduction................................................................................................................................2
Infrastructure in emerging markets............................................................................................2
Conclusion..................................................................................................................................3
Reference list..............................................................................................................................4

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Introduction
The emerging markets has now become an attractive place for business expansion and
investment with their prospective economic growth and an improved legal and physical
infrastructure. However, the opportunity for investors investing in emerging markets come
along with multifaceted risk. One such risk is the risk associated with a volatile exchange
rate.
Infrastructure in emerging markets
A weak infrastructure is characterized as existence of weak governance, political
instability, corruption and a weak legal system hampers the secure business environment. The
weak infrastructure increases risk of investment return. The steady flow of foreign funds
needs a stable economic structure characterize with a stable government, laws and regulation
and a stable currency (Ramasamy and Abar 2015). In a volatile economic environment,
existing foreign investors withdraw their funds. As the supply of foreign reserves reduces,
this has a general tendency of increasing exchange rate making the currency weak as
compared to other countries. Weak infrastructure reduces the interest rate that further
weakens currency. In the past 25 years, developing countries had lost almost 72% of their
currency value in terms of US dollar. Nearly one fifth of emerging countries lost 99% value
of their currencies (Wójcik, MacDonald-Korth and Zhao 2017).
Under this circumstance, the choice of appropriate exchange rate regime plays an
important role. In a flexible exchange rate regime, exchange rates are free to float in the
foreign exchange market and the relative price of currency is determined with demand and
supply of foreign exchange reserves. In a completely free regime, when foreign funds are
withdrawn in response to a relatively low interest rate then relative price of currency
continues to fall (Uribe and Schmitt-Grohé 2017). The countries then suffer from a lack of

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foreign fund and face trouble for importing necessary raw materials. However, with a fixed
exchange rate system central bank takes necessary steps to maintain the currency value to a
certain level. This though makes currency less vulnerable to currency shocks resulted from
weak infrastructure or other factors but imposes additional burden on government inhibiting
domestic growth. Therefore, it is desirable for emerging countries to adapt a pseudo-flexible
rate regime (Frisch and Worgotter 2016). This is to keep the exchange rate free in the market
but maintain enough stock of reserve to inject in the economy during volatile situation.
Conclusion
As discussed above weak infrastructure weakens currency of the domestic economy.
The weak currency lowers the interest rate. This reduces investor’s confidence and hampers
economic growth. The volatile currency resulted from weak infrastructure thus has a serious
consequence for emerging markets.

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Reference list
Frisch, H. and Worgotter, A. eds., 2016. Open-Economy Macroeconomics. Springer.
Ramasamy, R. and Abar, S.K., 2015. Influence of macroeconomic variables on exchange
rates. Journal of economics, Business and Management, 3(2), pp.276-281.
Uribe, M. and Schmitt-Grohé, S., 2017. Open economy macroeconomics. Princeton
University Press.
Wójcik, D., MacDonald-Korth, D. and Zhao, S.X., 2017. The political–economic geography
of foreign exchange trading. Journal of Economic Geography, 17(2), pp.267-286.