Why countries like Argentina and Turkey fret about exchange rates
IMAGINE if Milton Friedman had been put in charge of a central bank, only to lose his job for expanding the money supply too quickly. Or if Robert Shiller, the Nobel-prizewinning author of “Irrational Exuberance”, were given a similar post, only to depart having allowed a stockmarket bubble to inflate. That is the kind of irony that attended the resignation under pressure of Federico Sturzenegger as governor of Argentina’s central bank on June 14th, a casualty of deepening turmoil in emerging markets.
Mr Sturzenegger was a former professor at Universidad Torcuato Di Tella in Buenos Aires. His most-cited paper showed that stated currency policy was often a poor guide to actual policy. Many countries claim to let their currencies float freely but in fact “intervene recurrently to stabilise their exchange rates”. Their deeds often belie their words.
Mr Sturzenegger lost his job for much the same thing. Financial markets struggled to reconcile his statements on the currency with his management of it, eroding his credibility. After Argentina agreed on a $50bn loan from the IMF, he said he would intervene in the foreign-exchange market only in “disruptive situations”. But when the peso soon came under renewed pressure, he resumed selling foreign-exchange reserves, which fell by $665m on June 12th-13th. He gave up the fight on June 14th, allowing the currency to drop by 5.3% against the dollar on a day that ended with his departure.
Why do policymakers in emerging markets fret so much over exchange rates? A weak currency, after all, makes a country’s exports and assets more competitive. And when capital flees, it can be better to let the currency fall than to put up interest rates (and throttle growth) in an effort to keep the exchange rate stable.
One reason to worry is inflation. Weaker currencies push up import costs, jeopardising price stability. The plummeting Turkish lira, for example, has hampered the fight against inflation in a country where prices respond quickly to currency weakness. In response, Turkey’s central bank, like Argentina’s, has been forced to raise interest rates dramatically, despite the opposition of Recep Tayyip Erdogan, who is seeking re-election as president.
According to Capital Economics, financial conditions in both countries have tightened by more this year than they did in the same period of 2013, the year of the “taper tantrum”, when America’s Federal Reserve said it would eventually slow its pace of quantitative easing. In many other countries, however, this year’s tantrum is not yet as bad as its forerunner. Brazil’s currency has fallen by 9% since mid-April. But the central bank has refrained from raising interest rates, insisting that there is no “mechanical relationship” between recent shocks and monetary policy.
Another reason to worry about exchange rates is debt: a weaker currency makes dollar or euro liabilities harder to repay. According to the Institute of International Finance, the combined foreign-currency debt of Argentina’s government and non-financial companies exceeds 50% of GDP. In Turkey, it is 47%. But the burden elsewhere is modest. It is less than 25% of GDP in Mexico and South Africa, less than 20% in Brazil and Malaysia, and closer to 10% in India, China and Thailand.
In Indonesia, both inflation (3.2%) and foreign-currency debt (19% of GDP) are low. Its central bank nonetheless raised rates twice in May to stabilise the rupiah. The country, still haunted by the Asian financial crisis, associates a falling currency with a faltering economy. And like other emerging markets, it fears that currency weakness can feed on itself, as declines fuel speculation about further declines.
This is presumably the kind of “disruptive situation” that Mr Sturzenegger had in mind when positing exceptions to his rule of non-intervention. He was perhaps unfortunate that such a situation arose so shortly after he had promised to step back: the sharp drop in Argentina’s peso on June 11th was exacerbated by the Federal Reserve’s hawkish signals after its meeting on June 12th-13th. In emerging markets, currency policy can be complicated—not least because of the financial markets’ demand for simplicity.