Governance, Institutions, and Macroeconomic External Stability: Insights from South Asia

Abstract

Balance of payments (BOP) dynamics have become significant in recent times due to increased trade integration, external borrowing, and investment. Many South Asian nations often experience balance of payments (BOP) pressures due to trade shortfalls, reliance on imports, and variations in foreign exchange revenues. The objective of this study is to examine the impact of institutional quality on balance of payments (BOP). The four South Asian nations are selected for this analysis, i.e., Bangladesh, Sri Lanka, India, and Pakistan. The time period of this study is from 1996 to 2023. The predicted variable of this study is the balance of payments, while the set of explanatory variables are control of corruption, government effectiveness, voice and accountability, and political stability. Data on all macroeconomic variables are taken from the World Development Indicators. To account for unobserved heterogeneity across nations, the study uses a fixed effects regression model as a method of estimation. The Hausman test is used to select between the fixed-effect and random-effects models. The findings show that both real interest rates and inflation have a major impact on the Balance of Payments (BOP), with real interest rates having a positive effect on the balance of payments and inflation having a negative one. Notably, the analysis shows that the Balance of Payments (BOP) is significantly shaped by the management of corruption, political stability, government efficacy, and voice and accountability. However, the study reveals a negative correlation between Balance of Payments (BOP) and government effectiveness as well as voice and accountability, indicating that stronger governance structures and more political freedom may be linked to external imbalances in these nations. This analysis recommended that Central banks in these nations ought to give priority to measures that keep prices stable and control inflation. Because high inflation reduces competitiveness and raises demand for imports, it hurts the Balance of Payments (BOP). Inflationary pressures can be lessened by measures meant to manage exchange rate volatility, manage government spending, and tighten monetary policy. In order to improve political stability, government efficacy, and corruption control, governments should prioritize improving the quality of their institutions.