EM Real Effective Exchange Rates Hardly the Stuff of Competitive Devaluation
by Win Thin
With all this talk about currency wars, several points need to be made. The most important one that we have been stressing is that EM currencies are stronger now than they were a year ago, hardly the stuff of competitive devaluation. Yes, many policy-makers are trying to limit currency strength but moves are by no means a mercantilist, “beggar-thy-neighbor” approach. In addition, we think it’s important to make the distinction between bilateral exchange rates vs. USD and real effective exchange rates (REER). EM policy-makers are worried about strong currencies vs. USD, but the REER is what really matters for trade and competitiveness, as it takes into account trade shares and relative inflation rates. JP Morgan has a comprehensive data set for historical REERs for both EM and G10 that we find very useful. Changes in the REER are surprising for some countries. For instance, Korea’s concerns about a strong won seem misplaced as its REER is almost 25% weaker than it was in January 2007.
Looking at the rest of emerging Asia, Taiwan’s REER is about 10% weaker than January 2007, Malaysia and India both about 2% weaker, and PHP about 12% weaker. On the flip side, China’s REER is about 10% stronger than it was in January 2007, while the big outlier is Indonesia, whose REER is about 25% stronger than it was in January 2007. Thailand REER is about 11% stronger than January 2007 and Singapore REER is about 4% stronger than January.
In Latin America, it is clear that Brazil has a justified concern about the strong real, as its REER is up an astounding 40% since January 2007. Colombia is next (REER up 20%), followed by Chile (up 16%) and Peru (up 11%). Here, Mexico is the outlier with an REER that is almost 10% weaker than it was back in January 2007. So it’s not a coincidence that Brazil has been the most active in trying to manage currency strength, with Colombia, Chile, and Peru seeing increased concerns about their respective currencies. Mexico does not seem concerned about the peso exchange rate.
In EMEA, REERs are mixed compared to what they were back in January 2007. Notable strength is seen in Israel (REER up almost 20%), South Africa (up 13%), Russia (up 11%), and Czech (up 11%), while weakness/stability is seen in Turkey (down 2%), Poland (up 1%), and Hungary (down 3%). Here too, Israel and South Africa have been the most active and vocal with regards to offsetting currency strength.
Make no mistake, EM policy-makers would always prefer a weaker currency over a stronger one. But it’s clear from looking at many of the REERs that the complaints are misplaced. Indeed, US Treasury Secretary Geithner could point to this data and call on EM policy-makers to allow even more currency strength than has been allowed, as many countries are not yet experiencing the significantly stronger REERs that are needed to help correct global imbalances. Over the long-term, these imbalances need to be corrected as EM can no longer count on the US to grow 3-4% and continue sucking in imports of electronics, autos, etc. Instead, EM policy-makers must work to rebalance their economies towards greater consumption and less saving/exporting. In the grand scheme of things, this is a multi-year process but at the margin, stronger currencies will help rebalance emerging economies away from export-orientation and towards greater domestic consumption.
Win Thin | Global Head Of Emerging Markets Strategy