BIS Study: Countries with 5% Fiscal Deficits Show 35% Exchange Rate Pass-Through vs 17% for Those with Surpluses

According to the Bank for International Settlements (BIS), a paper released yesterday (July 26) found that countries with fiscal deficits exceeding 5% of GDP experience significantly higher exchange rate pass-through rates. The study, analyzing 40 years of data from 98 countries, revealed that when fiscal deficits exceed 5%, currency depreciation translates into a 35% pass-through to inflation, compared to just 17% when countries maintain a 5% fiscal surplus. BIS attributed this to market perception that governments unable to credibly commit to future fiscal surpluses may tolerate inflation to stabilize real debt values.

Inflation levels proved equally important. The pass-through rate remained suppressed when average inflation stayed low, but nearly doubled when inflation exceeded 5%, suggesting that maintaining low average inflation helps contain the inflationary impact of currency fluctuations.