Do Developing Countries Still Suffer from the Foreign Exchange Constraint? An Empirical Study for 1990–2014

Abstract

Globalization can potentially ease or firm up the foreign exchange constraint of a country. Considering a sample of 42 less developed countries and fixing an approximate date of globalization in 1991, we show that, at the aggregate level, the constraint has relaxed for them since the 1990s. After fixing the approximate dates of globalization for each country from the available literature and replicating the analysis at the country level, we found mixed results. Though the results are mixed, a general conclusion can be derived from the results: The foreign exchange constraint has relaxed due to globalization in upper-middle and lower-middle-income developing countries, while the opposite is true for low-income countries. Balance-of-payment accounting statistics show interesting correspondences. Merchandise exports and Foreign Direct Investment (FDI) tend to have a high and positive correspondence with relaxing the burden of the constraint while Foreign Portfolio Investment (FPI) and efforts toward reduction of imports have no correspondence. Policy insights derived from the analysis suggest export diversification is important for improving current account balance.

… The problem for many developing countries is the deficiency of productive capacity and not the anomaly of its underutilization and … the availability of foreign exchange may become, under many circumstances, the principal factor limiting economic activity. Demand constraints do exist … but supply constraints generated either by the availability of capital or by the availability of foreign exchange are more important.

Stiglitz et al. (2006: 56)

Appendices

Appendix 1

Let the utility function be

$$ U\left[ {D_{t} ,M_{t} } \right] = N\frac{{D_{t}^{1 - \alpha } }}{1 - \alpha } + R\frac{{M_{t}^{1 - \beta } }}{1 - \beta }. $$

Therefore, the current-value Hamiltonian will now be

$$ \begin{aligned} H_{c} & = N.\frac{{D_{t}^{1 - \alpha } }}{1 - \alpha } + R\frac{{M_{t}^{1 - \beta } }}{1 - \beta } + \lambda_{t} \left[ {\theta A_{t} K_{t} - D_{t} - P_{t} M_{t} .} \right] \hfill \\ & \quad + \lambda_{A} ((\sigma - \gamma )A_{t} ) + \mu_{t} (F_{t} - P_{t} M_{t} ) \hfill \\ \end{aligned} $$

The first-order conditions are

$$ ND_{t}^{ - \alpha } = \lambda_{t} $$

(18)

$$ RM_{t}^{ - \beta } = P_{t} (\lambda_{t} + \mu_{t} ), $$

(19)

$$ \begin{gathered} F_{t} - P_{t} M_{t} \ge 0 \hfill \\ \mu_{t} \left[ {F_{t} - P_{t} M_{t} } \right] = 0. \hfill \\ \end{gathered} $$

Eliminating λ_t from (18) and (19), we have.

$$ND_{t}^{ - \alpha } P_{t} \left[ {1 + \mu_{t}^{ * } } \right] = RM_{t}^{ - \beta }, $$

where $\mu_{t}^{ * } = \frac{{\mu_{t} }}{{\lambda_{t} }}$ is the change in the marginal utility of foreign exchange availability to the marginal utility of domestic goods.

Taking log on both sides yields

$$ \log M_{t} = \frac{1}{\beta }(\log R - \log N) - \frac{1}{\beta }\log P_{t} + \frac{\alpha }{\beta }\log D_{t} - \frac{1}{\beta }\log (1 + \mu_{t}^{*} ). $$

(20)

Let the functional form of $\mu_{t}^{*}$ be

$$ \mu_{t}^{*} = e^{{\theta_{1} Z_{t} }} - 1, $$

where Z_t is the ratio of foreign exchange reserve to the GDP (Xu, 2000). We, therefore, assume that the change in the marginal utility of foreign exchange availability to the marginal utility of domestic goods is a function of the ratio between domestic expenditure and foreign exchange availability. Therefore,

$$ \log (1 + \mu_{t}^{*} ) = \theta_{1} Z_{t} . $$

Let Z_t be the ratio between domestic expenditure and foreign exchange availability.

Thus, Eq. (20) can be rewritten as

$$ \log M_{t} = \frac{1}{\beta }(\log R - \log N) - \frac{1}{\beta }\log P_{t} + \frac{\alpha }{\beta }\log D_{t} - \frac{{\theta_{1} }}{\beta }Z_{t} . $$

(21)

In Eq. (21), $\frac{{\theta_{1} }}{\beta }$ is our coefficient of interest. In what follows, we estimate Eq. (21)—or equivalently Eq. (14)—using our sample of countries and years.

Appendix 2

Unit Root Test (Phillips-Perron)

Country	Level				First difference
	LM	LGDP	LP	Z	LM		LGDP	LP		Z
Argentina	−2.24	−1.96	−3.05	3.04	−4.6		2.97	−3.48		−5.27
Benin	−3.08	−1.65	1.71	−1.96	−8.04		−5.43	8.04		−6.41
Bhutan	−6.29	−2.06	−1.29	2.94			−7.34	−5.39		7.04
Brazil	−2.43	−1.33	−1.19	−0.23	−6.06		−3.71	−3.74		−4.15
Burkina Faso	−0.92	−1.69	−2.29	−2.26	−6.48		−6.15	−5.85		−4.31
China	−3.47	−2.60*	−2.91	−0.17	−6.45*		−6.71*	−6.46*		−4.91*
Congo (Rep)	2.94	−2.29	−1.72	1.53	−8.1		3.62	−3.53		4.72
Dominican Republic	1.06	1.94	−2.33	−2.26	−7.46		4.47	4.6		−5.21
El Salvador	−3.47	−1.61	−1.91	−0.17	−6.45*		5.76*	−6.46*		−4.91*
Ethiopia	−0.44	−2.36	−1.37	−2.77	8.4		−6.13	−4.87		−5.54
The Gambia	−2.9	−2.05	−1.44	−1.78	5.75		−3.82	−5.22		−5.73
Guinea−Bissau	−0.69	−2.8	−0.37	1.6	−5.09		−3.6	−4.67		4.86
Haiti	1.06	1.94	−2.33	−2.26	−7.46		4.47	1.06		1.94
Hungary	−1.46	−2.2	1.11	−2.04	−3.83		6.6	3.83		−6.13
India	1.91	2.46	3.11	1.12	−5.15		−4.82	−5.52		−6.7
Jordan	−1.41	−2.66	2.46	−0.73	−5.16		−3.99	−5.7		−3.58
Libya	−3.28	−0.34	−0.27	−3.46	−5.72		−4.32	−5.89		−4.87
Malawi	−1.85	−1.44	−1.5	−2.23	−6.57		−4.99	−15.35		−5.43
Malaysia	−1.96	−1.96	−2.56	−3	−5.56		−5.4	−3.15		−5.16
Mauritius	−1.87	−2.41	−2.92	−2.37	4.5		−5.41	4.37		−5.28
Morocco	−1.41	−2.66	2.46	−0.73	−5.16		−3.99	−5.7		−4.87
Nicaragua	−0.16	−2.83	−2.65	0.65	4.56		−5.59	6.99		4.89
Pakistan	−3.39	−3.16	−3.44	−3.64	−6.92		−7.3	−5.26		−4.1
Paraguay	−2.48	−1.65	−1.32	1.37	−4.74		−3.73	−4.87		4.55
The Philippines	−6.19	−4.73	−4.08	−4.65
Rwanda	2.97	−2.19	0.77	−1.8	9.36		−4	−6.02		−4.82
Senegal	−2.06	−1.96	0.4	0.85	−5.21		−5.23	−5.79		−5.79
Somalia	−2.27	−2	−3.04	−1.24	−7.03		−8.47	−8.24		−4.86
Sri Lanka	−2.12	−2.89	−2.22	−2.82	−4.52		−4.95	−4.5		−4.68
Thailand	−1.59	−3.53	−3.22	−2.9	−4.24		−8.08	−8.1		−4.57
Togo	1.72	2.92	−3.04	−1.94	−7.07		−6.83	−8.89		8.6
Trinidad & Tobago	−1.34	−1.71	−2.67	−2.26	−5.36		−3.91	−5.95		−3.66
Tunisia	−3.29	−1.79	−2.71	−1.17	−6.75		−6.61	−3.69		−5.5
Turkey	−2.07	−1.49	−1.81	−1.27	−3.83		−5.8	−4.27		−4.63

Unit Root Test (for ARDL)

Country	Level				First difference
	LM	LGDP	LP	Z	LM	LGDP	LP	Z
Bangladesh	−3.47	−4.60*	−2.91	−0.17	−6.45*		−6.46*	−4.91*
Kenya	−2.05	5.07*	−2.45	−3.05	−4.48*		−3.95*	−10.54
Bolivia	−3.79*	−1.75	−1.02	−1.26		−3.99*	−3.56*	−3.60*
Burundi	−2.90	−1.73	−1.24	−5.61*	−7.02*	−3.57*	−6.30*
Central African Republic	−4.19*	−2.02	−2.95	−2.62		−6.27*	−6.97*	−4.34*
Chad	−3.21	−1.57	−3.90*	−5.50*	−6.44*	−6.05*
Costa Rica	−0.69	−2.80	−0.37	3.60*	−5.09*	−3.60	−4.67
Mauritania	4.76*	−3.14	6.45*	4.39*		−8.55
Papua New Guinea	2.81	−3.18	4.087*	−1.53	−6.57*	−5.27*		3.60*
Swaziland	3.47	−3.60*	3.67*	−2.71	−5.61*			−5.64*