Revaluing due to prosperity: policymakers are increasingly letting their currencies appreciate against the dollar.
That means it becomes costlier for USD and Euro to purchase the stuff produce by the emerging markets.
As a result, several mamatas end.
For instance the cars are sold internally and no exported cheap cheap.
Gave the example the other day to klaser in which, a Danish company was buying wood, shipping to Vietnam and making furniture there.
These guys are very good for the world economy mind you. They are the Lebanese of the world. Greasing the economy and making the best of cheap cheap materials and cheap man power and getting their cut of the deal.
I'm not saying that this is bad. I am just saying that this arbritraging will end as the cost of emerging market products increase.
This is execelent for the world's economy, because they now can purchase the products of the developed world.
Revaluing due to prosperity.
RUCHIR SHARMA
TIMES NEWS NETWORK[ TUESDAY, JUNE 05, 2007 03:27:03 AM]
Central banks in emerging markets spent much of the past few decades pursuing an exchange rate policy that often read: “Undervaluing our way to prosperity”. But the power of capital inflows has been so overwhelming of late that the new policy paradigm seems to be more along the lines of: “Revaluing our way (due) to prosperity”.
From Brazil to Indonesia, policymakers are increasingly letting their currencies appreciate against the dollar. Several emerging market currencies have registered double-digit percentage gains over the past year, with the Brazilian real and the Turkish lira rising by nearly 20%. Similarly, currencies in other regions have notched up double-digit gains such as the Philippine peso and Thai baht in Asia and the Slovakia koruna in Eastern Europe — they have all revalued by around 15% in the last 12 months. The Indian rupee just about makes the cut of the world’s ten best-performing currencies, on the back of a 14% year-over-year gain.
Economic equations in the Middle East too were shaken up a fortnight ago when Kuwait became the first of the six Gulf Cooperation Council, or GCC countries to drop its 14-year old peg against the dollar. After long resisting such a change, Kuwait finally succumbed to revaluation pressures in a bid to regain some control over its monetary policy. It was otherwise being forced to cut interest rates despite an accelerating inflation rate, just to prevent huge foreign inflows.
With several central banks explicitly adopting an inflation-targeting regime, it was only inevitable that policymakers would let the value of their currencies be more market-determined, given the threat of rising inflation in the advanced stages of the economic cycle. It is remarkable how many central banks in developing countries are now targeting an inflation rate in the range of 3 to 4%.
They haven’t quite forgotten the 1970s when most central bankers ran easy monetary policies to shore up domestic demand and by mistake accommodated the commodity price boom. In contrast, despite the sustained and pronounced increase in commodity prices in the current cycle, inflationary expectations have remained well anchored with the average inflation in developing countries currently at an all-time low of 5.5%.
While the predominant objective of central banks such as the Reserve Bank of India has been to control inflation, with the exchange rate acting as a tool in that effort, other central banks have been motivated by different factors in adjusting their currency management policy. For example, it was turning out to be too expensive for Banco Central Do Brasil, or BCB, to buy up to a billion dollars a day to keep to hold the real at 2.0 versus the dollar — an issue it faced earlier the year. With Brazilian interest rates still more than twice the level of US rates, the cost of sterilisation is rather prohibitive; Brazil’s $130 billion in foreign exchange reserves yield far less to the BCB than what the bank ends up paying on the domestic bonds it issues to mop up dollar liquidity.
Indonesia has been facing a similar predicament and has also allowed the rupiah to strengthen significantly against the dollar. The more relaxed exchange rate intervention policy has been further abetted by the continued encouraging performance on the export front despite a rapid rise in their currencies. Many developing countries are net commodity exporters and the surge in commodity prices has helped offset the potential negative effect from a rising exchange rate.
More interestingly, even in some commodity importing countries, such as in Eastern Europe, central banks have accepted upward pressure on their currencies as a natural consequence of a productivity boom. A strong reform momentum and continued benefits from greater integration with the European Union has led to very high productivity growth in Romania, Slovakia and other smaller Eastern European countries. Foreign direct investment flows have been gushing in, allowing these countries to easily finance large current account deficits.
In fact, the breakdown in the linkage between a current account deficit and exchange rate performance highlights how movements in the capital account are now completely overshadowing the current account. This is reducing the importance of exports in the economic equation; policymakers know they can get growth going through domestic demand in a low interest rate and a high productivity environment.
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