Question

According to a recent UN report, International Foreign Direct Investment (FDI) flows may contract by up to 15 percent due to Covid-19, while the capital outflows from the emerging economies have already exceeded US$97 billion since January 2020.

How would this affect the currency exchange rates in emerging markets? Mention the reasons for your answer .

Answer 1

The currency of the emerging markets will depreciate.

When the FDI investment is done, the foreign currency is converted to local emerging currency and it creates demand for the local currency and it appreciates. So as the investment will drop, so the demand of currency will drop and the currency will depreciate.

Mostly emerging markets run on Fiscal deficit. This deficit is being met by FDI investments. As the FDI investments will lower, so the countries will have to use reserves to meet deficit, which will depreciate the currency further.