Recent exchange rate developments and the scope for G20 international collaboration

A global imbalances are beginning to widen again foreign‐exchange markets have experienced increasing volatility in recent weeks with large swings in bilateral rates resulting in often large changes in effective rates. Some of these movements are consistent with an adjustment in imbalances. In the case of the dollar, its depreciation (4.2% since 1 September in nominal effective terms) contributes to the rebalancing of US production from internal to external demand and alleviates deflationary risks in the United States. Similarly, the moderate appreciation that has occurred in emerging market economies such as Brazil and India (1.1% since 1 September in nominal effective terms in both countries) should help them to contain inflationary pressures but may exacerbate their current account deficit unless it is compensated by fiscal tightening.
On the other hand, some other exchange‐rate movements go in the opposite direction. The substantial appreciation of the euro (4.1% in nominal effective terms since 1 September) will reinforce deflationary risks. In Japan, yen appreciation would exacerbate deflation but would help to reduce the current account surplus. In China, the renminbi, which has remained tightly linked to the dollar, has depreciated substantially in effective terms (2.3% per cent since 1 September), which works against the rebalancing of the economy toward domestic demand. Furthermore, by adding to general economic uncertainty, increased volatility in foreign exchange markets is bound to dampen growth.
In current conditions the appreciation of emerging‐market currencies is a normal and welcome adjustment to the fact that emerging economies enjoy a better economic outlook than most OECD countries. The downside for emerging‐market economies is that, if the exchange rate moves by a large amount, it may lead to an uneven distribution of the adjustment burden with the exposed sectors doing most of the adjustment and domestic sectors (and asset markets) being allowed to expand strongly. If the exchange rate movement is seen as a short‐lived overshooting, this could be an argument for temporary intervention to smooth the adjustment, but there is always a risk that this argument may justify intervention in cases where it does not really apply.
The fact that the largest emerging‐market economy is intervening massively to keep its currency from increasing is value considerably increases appreciation forces in other emerging‐market economies. This situation creates a risk of prompting series of interventions which would further increase the pressure on
1. This note represents personal views and not necessarily those of the Organization
countries that have not followed suit. This reminds us that, in general, foreign exchange intervention is not the most helpful instrument for macro‐economic management. It can prompt countervailing intervention abroad and ultimately poses a risk of triggering protectionist responses.
A much more desirable approach to rebalancing would count on a number of policy measures coordinated among major countries and regions. For example the policy scenario presented in the OECD Economic Outlook No. 87 incorporated substantial exchange‐rate realignments but also other measures. Most OECD currencies were assumed to fall by 10% immediately and by a further 1% per annum over the next ten years. The dollar was assumed to depreciate more, by a further 10%. In addition to the general assumed appreciation of non‐OECD currencies, the policy scenario also included a 20% rise in the external value of the renminbi over two years. Together with fiscal consolidation and structural reform, these exchange rate changes helped to generate domestic demand‐driven growth in external surplus countries and growth driven in part by foreign demand in deficit countries. Similar results have been reached in the simulations supporting the work carried out by the IMF (with inputs from the OECD) to identify an upside scenario within the G20 Framework for Strong, Sustainable, and Balanced Growth. Needless to say to achieve these results a strong commitment to continuing collaboration among the G20 is needed
From this point of view recent events in currency markets are a source of concern also because they signal the intention by a number of countries to pursue short term unilateral moves to address mounting imbalances and, implicitly, a disillusionment to pursue coordinated medium term actions. The conclusions of the G20 ministerial meeting in Gyengju (and hopefully the conclusion of the Seoul summit) have sent a more reassuring message as they indicate the will of the G20 countries to address the issue of imbalances, which may represent a serious obstacle to stable and sustained growth, although the practical implementation still needs to be worked out.. The Mutual Assessment Process based on the Framework for Growth will provide the institutional underpinning for the agreement of a coordinated solution that, hopefully, will address market concerns about the evolution of global governance.