Sharp Exchange Rate Depreciations Research Articles

Sri Lanka

Sri Lanka fell into an unprecedented crisis as a result of a series of shocks and policy missteps. Debt rose to unsustainable levels resulting from large fiscal imbalances, and access to international capital markets was lost soon after large tax cuts and the onset of the COVID-19. Reserves were depleted, leading to a sharp exchange rate depreciation, and debt service was suspended in the spring of 2022. Sizable monetary financing to meet fiscal obligations contributed to a surge in inflation. Sri Lanka’s economy is in deep recession and financial stability is at risk given the tight financialsovereign nexus. People are suffering from food and energy shortages, exacerbating deep-rooted public dissatisfaction and creating a vulnerable political and social environment.

Fiscal sustainability: The case for Jamaica

Abstract The paper assesses the sustainability of fiscal policy in Jamaica alongside a large public debt stock, albeit falling, in the context of an economic reform program. In addition, the paper examines the risks associated with the large public debt stock. Fiscal reaction functions are used to assess fiscal sustainability via an OLS, VAR, GMM and VECM models while the vulnerability of the public debt stock is evaluated using the IMF debt sustainability analysis (DSA) framework through shocks to real GDP, primary balance, interest rate, real exchange rate, and a combined shock. After the implementation of the country's economic reform program, the results show that fiscal policy in Jamaica is on a path to attain sustainability. However, after adjusting the sample to exclude the economic reform period, the findings show that fiscal policy in Jamaica is unsustainability. Further, the results indicate that in the long run a primary surplus of 4.8 per cent of GDP would be required to achieve a public debt-to-GDP ratio of 60 percent. The risk assessment of the public debt reveals that Jamaica's debt is most vulnerable to sharp exchange rate depreciations and that the overall risk to the public debt stock is high. Of note, the DSA results should be interpreted in the context within which the framework is created in that it does not account for all dynamics within the economy and therefore may overstate the extend of the impact. In light of the results and given that foreign currency debt accounts for approximately 60 percent of the public debt stock, it is critical to rebalance the debt portfolio in favour of domestic debt.

Factors of Exports Dynamics and Import Substitution after the Sharp Exchange Rate Depreciation

The article deals with the problem of finding out factors promoting high export growth rates and successful import substitution after the sharp real exchange rate depreciation, which took place in Russia. The share of domestically-produced goods and services in domestic demand based on current prices, as well as the growth rate of the domestic demand covered by domestic production, are used as indicators for import substitution. Following the results of cross-country panel regressions, it is demonstrated that Russia’s positive net foreign assets position is favourable for export growth after the depreciation. On the other hand, the share of imported components in Russian non-oil-and-gas exports is close to the world average, so it cannot be stated that Russia’s export structure is favourable from the viewpoint of the magnitude of the depreciation’s positive impact. The analysis of Russia’s non-oil-and-gas exports dynamics measured in constant prices, shows that in recent years, the growth rates undershot the modeled ones. According to the net exports dynamics, in 2014–2015, this discrepancy was offset by the fact that the import contraction rates were significantly higher than the modeled ones. In 2016, however, the contribution of “additional” (as compared to the model) net exports fell to zero. The analysis also demonstrates that in the medium term, low quality of the institutional environment in Russia hinders maintaining momentum for exports and import substitution associated with the depreciation. Thus, despite the significance of the currently in-progress measures promoting non-commodity exports and import substitution, they should be complemented by constant efforts aimed at reducing investment risks, enhancing quality of governance, and safeguarding competition.

Capital Controls or Macroprudential Regulation?

International capital flows can create significant financial instability in emerging economies because of pecuniary externalities associated with exchange rate movements. Does this make it optimal to impose capital controls or should policymakers rely on domestic macroprudential regulation? This paper presents a tractable model to show that it is desirable to employ both types of instruments: Macroprudential regulation reduces overborrowing, while capital controls increase the aggregate net worth of the economy as a whole by also stimulating savings. The two policy measures should be set higher the greater an economy's debt burden and the higher domestic inequality. In our baseline calibration based on the East Asian crisis countries, we find optimal capital controls and macroprudential regulation in the magnitude of 2 percent. In advanced countries where the risk of sharp exchange rate depreciations is more limited, the role for capital controls subsides. However, macroprudential regulation remains essential to mitigate booms and busts in asset prices.

Trade policy reform and international trade tax revenue in Uganda

This paper contributes to the literature on the relationship between tariff reform and customs tax revenue by explicitly capturing the institutional features of decision making in the econometric modeling. The results show that exchange rate depreciation has had pass through effects to the domestic market price of imports which reduces trade tax revenue to GDP ratio in the long run, though it increases trade tax revenue in the short term. There are also seasonal patterns in the short term trade tax payment. The results point to some scope to harness the benefits associated with trade policy reform without having to worry a lot about its effects on trade (and overall) tax revenue. In fact, it would be possible to realise modest increases in trade tax revenue if the exemption regime were to be reviewed and if there was capacity to contain the disruptive impact of sharp exchange rate depreciations.

Currency Crashes in Industrial Countries: Much Ado About Nothing?

Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always had good economic consequences with stable or falling inflation rates.

Currency Crashes in Industrial Countries: Much Ado About Nothing?

Sharp exchange rate depreciations, or currency crashes, are associated with poor economic outcomes in industrial countries only when they are caused by inflationary macroeconomic policies. Moreover, the poor outcomes are attributable to inflationary policies in general and not the currency crashes in particular. On the other hand, crashes caused by rising unemployment or external deficits have always had good economic consequences with stable or falling inflation rates.

Recent Inflationary Trends in World Commodities Markets

Expansionary monetary policies in key industrial countries and sharply depreciating U.S. dollar exchange rate sent commodities prices soaring at unprecedented rates during 2003-2007. Food prices rose to alarming levels threatening malnutrition and food riots. In contrast, consumer price indices, a leading indicator for monetary policy, were showing almost no inflation and posed a price puzzle insofar their evolution was not responsive to record low interest rates, double digit commodities inflation, and sharp exchange rate depreciation. Commodities prices were shown to be driven by one common trend, identified as a monetary shock. Policy makers may have to face a policy dilemma: maintain monetary policy stance with accelerating commodities price inflation, subsequent world recession, and financial disorder; or tighten monetary policy with subsequent world recession followed by recovery and financial and price stability.

What Caused the 1991 Currency Crisis in India?

Which model best explains the 1991 currency crisis in India? Did real overvaluation contribute to the crisis? This paper seeks the answers through error correction models and by constructing the equilibrium real exchange rate using a technique developed by Gonzalo and Granger (1995). The evidence indicates that overvaluation as well as current account deficits and investor confidence played significant roles in the sharp exchange rate depreciation. The ECM model is supported by superior out-of-sample forecast performance versus a random walk model.

What Caused the 1991 Currency Crisis in India?

Did real overvaluation contribute to the 1991 currency crisis in India? This paper seeks an answer by constructing the equilibrium real exchange rate, using an error correction model and a technique developed by Gonzalo and Granger (1995). The results are affirmative and the evidence indicates that current account deficits and investor confidence also played significant roles in the sharp exchange rate depreciation. The ECM model is supported by superior out-of-sample forecast performance versus a random walk model.

The Interest Rate-Exchange Rate Nexus in the Asian Crisis Countries

Sharp exchange rate depreciations in the East Asian crisis countries (Indonesia, Korea, and Thailand) raised doubts about the efficacy of increasing interest rates to defend the currency. Using a standard monetary model of exchange rate determination, this paper shows that tighter monetary policy was in fact associated with an appreciation of the exchange rate. Moreover, there is little evidence of higher real interest rates contributing to a widening of the risk premium.

The Interest Rate-Exchange Rate Nexus in the Asian Crisis Countries

Sharp exchange rate depreciations in the East Asian crisis countries (Indonesia, Korea, and Thailand) raised doubts about the efficacy of increasing interest rates to defend the currency. Using a standard monetary model of exchange rate determination, this paper shows that tighter monetary policy was in fact associated with an appreciation of the exchange rate. Moreover, there is little evidence of higher real interest rates contributing to a widening of the risk premium.