Currency shocks spillovers and interconnectedness– evidence from emerging economies

Abstract

This study examines how international monetary policy shocks from developed economies impact emerging market currencies, focusing on interconnectedness and spillovers. Using a time-varying parameter vector autoregressive (TVP-VAR) model, the study analyzes daily exchange rate data for USD currency pairs from six emerging markets (India, Brazil, Russia, South Africa, Thailand, and Indonesia) from January 1, 2001, to May 31, 2023. Results show that the South African Rand (ZAR) is the largest transmitter of return shocks (13.25%), while the Russian Ruble (RUB) is the largest transmitter of volatility shocks (6.48%). The Indian Rupee (INR), Indonesian Rupiah (IDR), and Thai Baht (THB) are significant receivers of shocks. Increased interconnectedness is observed during economic crises, such as the Global Financial Crisis and the COVID-19 pandemic. Emerging market currencies are highly interconnected and sensitive to global financial shocks, emphasizing the need for proactive monetary policies to mitigate international spillovers and maintain financial stability. Central banks in emerging economies should continuously monitor global financial dynamics and adopt macroprudential measures to enhance policy credibility and institutional strength, thereby mitigating the adverse effects of external shocks on domestic economies.