MANAGING EXCHANGE RATE IN AN UNDIVERSIFIED ECONOMY

This paper examined the choice of exchange rate in an undiversified economy. A critical review of the literature on the exchange rate policy and economic diversification determinants was done. The analysis showed that infrastructure and the quality of institutions are important determinants of economic diversification. The country is in a better position to diversify its production base if it has a well-developed physical infrastructure and viable institutions. These findings have wide-ranging policy implications. First, government policies directed at improving government effectiveness and regulatory quality are essential for promoting economic diversification. Second, governments in resource-dependent countries can efficiently promote export diversification by fostering investment and trade freedom. Furthermore, governments in resource-rich countries need to take effective measures to offset the negative impact of large foreign exchange inflows on competitiveness. Effectively managing this is a major challenge for export diversification in resource-dependent countries. More broadly, governments need to grapple with the fact that policies aimed at the economic diversification may negatively affect the odds of export diversification. Finally, the choice of an exchange-rate regime depends on a country's characteristics, including its inflation performance, monetary credibility, its trading patterns, and its vulnerability to external shocks.