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Agencies
Washington
Gains from sharp declines in some emerging market and developing economy (EMDEs) currencies will be limited, as pricing decisions by companies are often made in dominant currencies such as the US dollar, according to the International Monetary Fund.
“Firms in EMDEs price their international sales and finance are financing themselves in a few dominant foreign currencies which alters how trade flows respond to exchange rates,” three senior IMF officials said in a joint blog post.
“Our analysis on dominant currencies suggests that the weakening of EMDE’s currencies is unlikely to provide a material boost to their economies in the short term as the response of most exports will be muted, besides the physical disruptions to trade from supply and demand disruptions,” according to the post from Gustavo Adler, deputy division chief in the IMF’s research department; Gita Gopinath, chief economist and Carolina Osorio-Buitron, an economist at the fund.
“Key sectors that would normally respond more to exchange rates like tourism are likely to be impaired by COVID-19-related containment measures and consumer behaviour changes.”
Exchange rates, they said, still have a role to play to contain capital outflow pressures and support recovery over the medium term. However, sustaining the domestic economy in the short term requires a decisive use of other policy levers, such as fiscal and monetary stimuli, including through unconventional tools.
Faced with an unprecedented shock of global demand and commodity prices collapse, capital outflows, supply chain disruptions and a drop in global trade, EMDE currencies have seen sharp drops in recent months. However, there is growing evidence that the majority of global trade is invoiced in a few currencies, most notably the US dollar.
The share of US dollar trade invoicing across countries far exceeds the trade with the US itself. This is especially true with EMDEs, which, given their growing role in international trade, is increasingly relevant for the international monetary system.
“When export prices are set in US dollars or euros, a country’s [currency] depreciation does not make goods and services cheaper for foreign buyers, at least in the short term, creating little incentive to increase demand,” IMF officials said.
“In EMDEs, where dominant currency pricing is more common, the reaction of export quantities to the exchange rate is more muted and so is the short-term boost of a depreciation of the currency to the domestic economy.”
The global strengthening of the US dollar has short-term contractionary effects on trade, as the weakening of other currencies against the greenback leads to higher domestic currency prices of imports of countries other than the US, resulting in lower demand.
The prevalence of the US dollar in corporate financing within EMDEs means that exchange rate fluctuations can also impact the balance sheets of firms in these economies.
A depreciation that increases the value of a firm’s liabilities relative to its domestic revenue weakens its balance sheet and hinders access to new financing, the fund’s officials said.
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22/07/2020
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