The impact of capital flows and monetary policy on exchange rate vulnerability: an empirical overview of the fragile five countries

Abstract

This study investigates how exchange rate dynamics in the Fragile Five economies are shaped by key macroeconomic and financial indicators, namely foreign direct investment inflows, the balance of trade in goods and services, the current account position, inflationary pressures, policy interest rates, and the level of foreign exchange reserves. Despite extensive research on exchange rate behaviour in emerging markets, empirical evidence focusing on financially vulnerable economies such as the Fragile Five remains relatively limited. This study examines the relationship between these variables using panel regression analysis for the period 1990–2023. The main objective is to identify the macroeconomic determinants influencing exchange rate movements in the Fragile Five economies. The results indicate that foreign direct investment and the net trade balance have a statistically significant positive effect on exchange rates, whereas the current account balance, inflation, and policy interest rates have significant negative effects. Foreign exchange reserves do not show a statistically significant effect. The findings provide empirical evidence on exchange rate vulnerability in emerging economies and offer insights for policymakers and investors.