Emerging market currencies are in disarray. Since the last spring meeting of the International Monetary Fund and the World Bank, Brazil’s bonds have been downgraded to ‘junk’ status, China’s stock market has faltered, and the Russian rouble has lost over half of its value against the US dollar.
Ahead of this week’s IMF and World Bank meetings in Lima, Peru, two issues will take centre stage: tighter US monetary policy and China’s slowdown. On both counts, this is an opportunity for the IMF to call for better coordination of exchange rate policy amongst the world’s major economic powers.
The IMF must be more vocal on currencies
IMF managing director Christine Lagarde has called for stronger domestic policies in emerging markets to help mitigate some of the risks associated with higher US interest rates and a slowing Chinese economy – two developments which the IMF deems ‘necessary and healthy’. However, it has largely been silent when it comes to global coordination against these risks.
On exchange rates, for example, the IMF should take a more courageous stance on treating exchange rates as a policy tool – rather than just a reflection of developments in the global economy.
Here are three ways how:
- Warn against US dollar strength
The US dollar has strengthened by 20% since May 2013, and is now overvalued by up to 14% according to the OECD. Any more, and it will become problematic for countries – like Nigeria and Angola – which have high debt (serviceable in dollars), a low level of reserves, and fixed or managed exchange rate regimes.
- Give a timeline for including China’s currency in its ‘SDR basket’
China’s central bank has been spending up to $100 billion a month in foreign exchange reserves to defend its currency since the 11 August devaluation. The IMF could support China to mitigate speculative pressure on the renminbi by giving a timeline for including it among the currencies for which it has special drawing rights (SDR). With China taking the G20 leadership, this could mark the start of a broader paradigm shift as China becomes more vocal on its renminbi policy.
- Call for revamped currency coordination
Decades ago, the Plaza and Louvre Accords helped adjust an inappropriately valued US dollar – a coordinated intervention with a positive impact on global economic partnership. Today, the global economy faces even bigger risks and yet the IMF hasn’t made coordination on tackling exchange rate volatility a major focus.
No individual BRICS country – Brazil, Russia, India, China, South Africa – has enough reserves to defend itself against a speculative attack on its currency. And some are particularly vulnerable to a currency crisis in the next year; with the exception of India, they have all seen abrupt capital outflows and currency falls.
In the absence of global coordination, BRICS central banks should consider coordinated intervention, signalling a joint willingness to buy their currencies to stabilise the market. But as Ana Palacio writes, it remains to be seen whether the BRICs’ economic power can translate into economic influence.
In the long term, the IMF should give a more vocal and concrete signal that it supports global coordinated action to mitigate exchange rate risk – before another crisis occurs. It should not leave it too late: when currencies depreciate, countries see significant capital flight from their economies, with negative ramifications for their growth and investment prospects.
If the IMF continues to remain silent, emerging markets will experience much worse than a fifth year of slowing growth rates. A rising rate of corporate and sovereign debt defaults will reverberate in advanced economies as well.
As a chief financial strategist in a major investment bank recently reminded me, we live in a more interconnected world than ever before: US asset prices are now more influenced by developments in China than events in the US itself. Supporting emerging markets is not only of benefit to them but also to the health of the global economy as a whole. It is the responsibility of the IMF to protect against the ‘spillovers and spillbacks’ that it itself has warned against.