Exchange rates,

trade, FDI,
convertibility
Ben Slay
Senior economist
UNDP Bureau for Europe and CIS
 Exchange rates:
Policy issues

Different exchange rate definitions

What’s the “right” exchange rate regime?
– Fixed versus floating

What’s the right exchange rate level?
– “Strong” versus “weak” (“competitive”) exchange
rates

Related questions—
questions—Degrees of:
– Currency convertibility
– Regulation of:

Foreign exchange market

Banks
 Exchange rates:
Definitional issues

Nominal (market) exchange rates (somoni
(somoni/$)
/$)

Real exchange rate: nominal exchange rate
adjusted for inflation

Real effective exchange rate: nominal rate
adjusted for inflation—
inflation—and for trading
partners’ inflation

Purchasing--power-
Purchasing power-parity exchange rates: The
exchange rate at which the prices of identical
goods (or baskets of goods) cost the same in
two countries.
– Example: The Economist’s “Big Mac index”
 More on purchasing power
parity exchange rates
GDP per-capita (HDRO,
If:
(2007) EIU data)

Barriers to trade did
Country Nominal PPP Ratio not exist; and

Market exchange
rates were only
Latvia $12,620 $16,377 .77
affected by trade in
goods and services,
Russia $9090 $14,690 .62

Then: market exchange
rates would be PPP
China $2620 $5383 .49 exchange rates

In developing and
Ukraine $3090 $6914 .45 transition economies,
market exchange rates
Tajikistan $514 $1751 .29
are a fraction of PPP
exchange rates
 What’s the “right”
exchange rate?

“Competitive” versus “strong” exchange rates
– “Competitive” exchange rates promote exports, but
reduce living standards
– “Strong currencies” may become “over-
“over-valued”,
possibly causing currency crises

Successful development and transition mean:
– Gradual, but significant real exchange rate
appreciation

With improvements in productivity, competitiveness
– Market exchange rate approaches PPP rate

Lesson: Don’t permit exchange rate to
appreciate too much, too fast
 Exchange rate
regimes: Floating

Most flexible exchange rates in region are in
some new EU member states
– Examples: Poland, Czech Republic

Other examples: Turkey, Ukraine

Exchange rate determined by foreign
exchange market, monetary policy
– Simple, more discretion to:

Promote exports (weak exchange rate), or

Reduce inflation (strong exchange rate)
– “Inflation targeting” in response to capital inflows
– But more exchange rate risk
 Fixed exchange rates

Pegged rates: fixed to Euro, or dollar

– Hard peg, crawling peg, corridor
– Devaluation still possible (Armenia, Kazakhstan)
– Little control over monetary policy

Currency board: Devaluation not possible
– Money supply is multiple of foreign exchange
reserves
– Examples: BiH, Bulgaria, Estonia, Lithuania

“Euroisation” or monetary unification
– Montenegro, Kosovo, Slovenia, Slovakia
– Future for new EU member states?
 Most CIS countries have
“dirty floats”

Examples: Tajikistan, Russia,
Russia, Kyrgyzstan

Key characteristics:
– More central bank intervention in forex market
– Central banks unwilling to:

Fully commit central bank’s reserves to defend
exchange rate

Permit dual exchange rate regimes

Exceptions:
– Firmer exchange rates in: Kazakhstan,
Azerbaijan,, Georgia
Azerbaijan
– Dual exchange rate systems in: Uzbekistan
 Convertibility: Different
types, degrees

Types:
– Current-account v. capital
Current- capital--account convertibility
– Household v. enterprise convertibility
– Foreigner v. resident convertibility
– Internal v. external convertibility

Degrees:
– Limits on foreign exchange purchases?
purchases?
– Effectiveness of restrictions?

Limits on household convertibility can create dual exchange-
exchange-
rate regimes (e.g., Uzbekistan)

Limits on enterprise convertibility capital-
capital-account create illicit
capital flight
 Typical pattern: Gradual
increases in convertibility

Start: Resident enterprise convertibility for
current account transactions
– Goal: encourage import competition, import of
investment goods
– Expand from there

Final stages: capital account convertibility for
non--resident businesses
non
– Removal of controls on portfolio investment
transactions by investment banks
– Requirement of OECD, EU membership
 Trade liberalisation

Why liberalise trade?

– Exports: Market access
– Imports: Import competition, quality
modernisation

Particularly important for small, open
transition economies

How to liberalise trade?
– Multilaterally: WTO
– Regionally: EU (CIS? EurAsEC?)
 Multilateral liberalisation:
WTO membership

All new EU member states

Turkey, most West Balkan countries

FSU: Only Kyrgyzstan, Ukraine,
Moldova, Georgia, Armenia
– Prospects for other countries: very
uncertain
– Russia, Kazakhstan, Belarus: join together
as customs union?
 WTO: Key questions

Fate of current Doha round?

Decline in global trade in 2009:
– Impact on developing countries?
– Prospects for reversal?

Will other CIS countries join WTO?

How best to use WTO membership?
– Dispute resolution mechanism?
– Trade facilitation?
 Trade integration
within former Soviet space

Many different structures . . .
– CIS -- Eurasec -- CAREC
– Russian
Russian--Belarus monetary union

. . . None have been particularly effective

Sub--regions that most need economic
Sub
integration have the least of it:
– Central Asia -- Caucasus

Financing: Dollar, euro, rouble,
rouble, barter, yuan
yuan??

WTO membership could help . . . But how
much?
 Also important: “Behind
the border” trade barriers

For many CIS countries, “at the border”
trade regimes are relatively liberal

Most important barriers to trade are:
– Absence of trade finance
– Inadequate information about commercial
opportunities
– General obstacles to business/private sector
development

Response: “Aid for trade”
– ODA/technical assistance for trade facilitation in
developing countries
Foreign direct investment

Three types:
– Resource based
– Focus on domestic markets

Consumer-oriented
Consumer-

Cheaper to produce there than export there
– “Export
“Export--platform”
platform”——reflects EU accession,
integration

Driving force of “convergence growth”
for new EU member states
What’s different about FDI
in new member states?

Sheer amounts:
– Czech Republic: $11,500 per capita FDI
– Kazakhstan: $4150 per capita FDI

FDI starts with privatisation
privatisation,, but
continues as greenfield

Export platform logic dominates . . .

. . . But “commanding heights”,
infrastructure also sold:
– Banks -- Utilities
– Transport -- Telecoms