This Policy Brief was first published in https://t20ind.org
Reducing borrowing costs for emerging markets (EMs) remains a massive challenge. While the interest rate differential (IRD) is near- zero for advanced economies, for EMs, it is always positive. Excess exchange rate volatility is often due to global and not domestic factors, so that a pure float fails to act as a shock absorber. The additional country risk premia that foreign investors seek are primarily driven by a fear of unexpected currency depreciation; which often does not take place, and thus there are positive excess returns from EM assets. To reduce EM IRDs, exchange rate volatility, risk and risk-perceptions have to fall. A suitable exchange rate regime and domestic as well as international prudential regulation on cross-border capital flows can lower exchange rate volatility. Global pooling/insurance mechanisms and better payment systems can reduce exchange rate risk at a low cost. If the G20 communiqués address these issues it could help reduce risk- perceptions.
