Some of the worst performing currencies of the year include the Turkish lira and the Argentinean peso, declining by 52 and 37 per cent respectively against the US dollar. In the past year, this acute depreciation of currencies from developing countries has become the norm rather than the exception, and the effects of this phenomena has been greatly felt by the people living in these societies, as they are hit by a decline in the standards of living and an increase in the cost of the market basket. What are the factors driving this crisis? and what are the possible solutions? These were some of the questions that were answered by Nora Neuteboom, the economist for ABN Amro, and Professor Sweder van Wijnbergenthe on December 10th, in an interview for Room for Discussion, here is a brief summary of what was discussed.
What is causing this crisis?
According to Nora Neuteboom, when analyzing the nature of this turmoil it is best to focus on three separate levels. The monetary tightening of the policy in the united states and its inherent impact in the capital flow of emerging markets; the disappointing growth in the eurozone compared with the steady growth occurring in the United States; and the oil and the changes in oil and commodity prices given that many emerging markets are exporters of these raw materials. However, Sweder van Wijnbergen disagrees, he perceives all these as general volatility factors, which are not able to explain why some countries are going through this crisis and other emerging markets such as China or India are not. Currently, we are witnessing depreciation mainly in countries with low credibility, weak political institutions and bank supervision that have a large current account deficit. Therefore, it is best to examine why were banks in Turkey or Argentina allowed to take on so much risk which is a classic moral hazard problem were banks think that they are “too big to fail” and that they’ll get bailed out by the government.
Another factor driving this crisis is the fact that most of the public and private debt in the affected countries is denominated in US dollars. This, of course, is a general problem encountered by countries with a history of unstable currencies. As investors lose confidence in them and demand debt in foreign coins in an attempt to secure themselves from changes in the exchange rate. This condition makes it difficult for policymakers to control the risks in the banking system. And added up to the strengthening of the US dollar, represents a classical currency miss-match problem where there is a growth in the value of the liabilities and a shrink in the value of the assets of a country. Besides this, there is also the current destabilizing trade wars as well as the Trump factor. Both being extremely unpredictable, which increases volatility in emerging markets. According to Professor Sweder van Wijnbergenthe the world has never witnessed such an unstable president in a leading country like the United States and the levels of unpredictability slow down the goods market and capital flows as any irreversible commitments will be thought twice
David Lubin an economist at Citibank has argued that the best thing to do for emerging markets is to get rid of the fixed exchange rates and to build up foreign exchange reserves to stay afloat in the global financial system. However, Mr van Wijnbergenthe does not agree with this, stating that the building up of reserves is not a solution because it’s just an insurance against a crisis, not a prevention mechanism. He argues that instead, countries should strive to eliminate high fragility. In the same sense, Nora Neuteboom states that although reserves do act as a buffer in the case of a depreciation, it is important to target the real issues, and strive for a stable growth model based on consumption, investment and productivity, not just credit. Countries in the west should take into account the effects of their policies in emerging markets and provide a stable currency environment to safeguard the growth in developing countries, making them less dependent on capital flows, in order to avoid the current drawbacks.