Does Budget Deficit and Political Stability Effect Real Exchange Rate in South Asian Countries?

Abstract

The study investigates the effect of political stability and budget deficit on the real exchange rate. We used a panel data set of south Asian countries, including Pakistan, China, Bangladesh and India. We applied the panel unit root test, Kaos panel Cointegration and fully modified the least square in the study to reach robustness of findings. Findings reveal that real exchange rate(RER) and political stability are positively related. It supports the argument that political stability attracts foreign investment, appreciates local currency, and leads to higher RER. However, results reveal that the budget deficit is not related to RER. This study provides new empirical evidence to policymakers and government officials that political stability encourages foreign investors and appreciates exchange rate.