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Temas Públicos Nº 862 - www.lyd.org- Email:[email protected] March, 28, 2008 ISSN 0717-1528 Dollar: There is Nothing We Can Do? The evolution in the exchange rate has been one of the most analyzed matters in the economic scenario of developing countries, both due to the discussion on the most convenient exchange system and to the evaluation of the possibility of “dollarizing” internal payments. Now, the average updated according to the CPI of the period January 1988 - February 2008 is of $758, which means that the current value, around $430, would be 43% lower than the average of the last 20 years, which warns us about a critical situation for the tradable sector. The nominal exchange rate decreased However, economics tells us that simply dramatically in Chile in the last months and updating the exchange rate according to the leaded to a discussion on the real effects of variation of the CPI is not the correct way for this path and the possibility that measuring competitiveness of the Central Bank interferes the economy, and recommends same way Argentina and Brazil If we want to balance this thus to use a concept named are doing. projection, we have the classic Real Exchange Rate (RER). This discussion arises in the middle of a generalized devaluation of the US Dollar, reason why the situation of the Chilean currency concerning other currencies will be discussed, as well as the economic policies that shall be implemented in this situation. alternatives: more national savings, more efficiency in all the sectors and public policies supporting both alternatives. If we don’t do anything, the TCR destiny for 2008 is already sealed. In a productive sector, competitiveness is focused in the comparison between local production costs and costs of producers located abroad. Thus, a productive sector is more competitive if it has less relative costs. Well, the level of the current exchange rate would be near 3.5% under the average observed in 1990 and the current year (see graphic N°1), so the difference of 43% already mentioned would be balanced by the lower price of inputs imported and the higher efficiency with which the national economy operates. Now, in March we would undergo a new downturn that would put this indicator near 14% under last year record. The evolution of the US Dollar v/s the Chilean Peso The first problem we face is related to the correct way to compare the exchange rate value along time, in order to confirm how high or low it is currently. In fact, if we take the nominal exchange rate since 1998, the last 20 years, and we adjust it according to the variation of the CPI (Consumer Price Index), we found that the value of the US Dollar in February 1998, adjusted that way, was equivalent to $1.164.per dollar, and that the lowest value was recorded in February 2008 and reached $467 per dollar. On the other hand, there are who affirm that the measurement made by the Central Bank of Chile is not the most appropriate and propose other methods to make that measurement. 1 analyze what can be done to avoid the above mentioned to happen. Graphic Nº1 Index of real exchange rate Base 1986 = 100 06 04 02 00 98 96 94 92 90 88 86 Promedio 90-07 = 93,5 What will happen with the downturn of the Real Exchange? The fall of the TCR means that, in relative terms, it is more convenient to buy goods and services produced abroad than locally. This means that the tradable sector is less attractive compared to the non-tradable, and productive inputs would be mobilized from one sector to another. Given that the exports basket is quite diverse, tradable sectors of natural resources are not affected the same way those that are more intense in the use of labour force. The measure informed in the last weeks is the intervention of the Central Bank in the exchange issue; which means, that the issuing agency will buy dollars, increasing its nominal value. Chile did it one decade ago to protect the exchange range and that meant gathering a great amount of international reserves and issuing bonuses at interests rates each time higher to avoid the inflationary pressure that might be developed due to the increase in the amount of national currency in the economy. Under the current conditions, this would increase the gap of low term rates with other countries, increasing the dilemma for the Central Bank, or it would relax inflation. ene-08 115 110 105 100 95 90 85 80 75 Is it useful that the Central Bank buys dollars? Lately, central banks of Brazil and Argentina have bought a great amount of dollars, as we can see in Graphic N°2. In Argentina, the reserves raised in USD$14.4 billion, equivalent to 41% of the reserves they had one year ago. In Brazil, the increase is even greater, because in the last 12 months the reserves increased in 91.8 billion, equivalent to 91% of what they had in February last year; i.e., they almost doubled the foreign currency stock under the control of the Central Bank. In Chile, the rate of exchange is almost nil and the reserves stock has remained quite stable. In addition, a higher industrial consolidation would appear, because moderation in costs generated by a higher operations scale will boost the concentration of production in less companies, each time bigger. The actions taken by the Central Bank of Brazil did not avoid the appraisal of its currency if compared to the US Dollar, and in fact, as we can see in Graphic N°3, in a higher magnitude than the Chilean peso’s. In Argentina, the situation is different and its currency is even more devaluated today than one year ago. However, this does not involve an increasing inflationary pressure. This, in turn, developed price con- At worst, we may see the most extreme version of the Dutch Disease, where the emergency of the an exports area generates such a downturn of the TCR that dissolves the rest of the export industry valid until that moment. As we can see, none of the scenarios is desirable for Chilean economy, so we must 2 duction of the VAT does not particularly help for this purpose, and even though the rate of this tax is quite high, reducing it is not a priority. Graphic Nº2 Evolution of International Reserves (billion dollars) 250,0 In matters of expenditure, if we consider that the government expenditure is more intensive in non-tradable goods than the private expenditure, we would conclude that a moderate attitude in public expenditure leaving more room for the private sector will contribute to outweigh our loss of competitiveness. 200,0 Brasil 150,0 100,0 Argentina 50,0 Chile 0,0 E F 08 trols over different goods and services that have distorted even more the Argentinean economy. Another example is the port tie-up occurred some days ago, because for many exporters this reflected a decrease of the US Dollar in many more pesos. In an exporting economy as the Chilean, located at thousand kilometres from destination countries, we should have the most efficient ports of the planet, and under no circumstance we would have a tie-up. What can we do then? The downturn of the TCR is effective and can create unwanted effects on Chilean economy, but the purchase of US dollars by the issuing agency does not solve the core problem and generates more serious consequences. This leads to focus the attention on competitiveness, because the downturn of the TCR clearly reflects that finally our production costs increased and this has undermined our relative position. 105,0 Argentina 100,0 95,0 Chile 90,0 85,0 Brasil 3 F E 08 D N 80,0 E 07 At this respect, there are short term and medium term measures. In the short term, there is a big opportunity for the authorities to reduce production costs through the elimination or restructuring of taxes. In that context, the total elimination of credit tax would help a lot. Likewise, the modification of the income tax for companies from an accrued basis would generate a similar effect to the one proposed by the authority one year ago, project of accelerated depreciation, that was rejected by the Congress. Thus, the re- Graphic Nº3 Index of nominal exchange rate (base Jan 2007 = 100) O D S N A S O J A J J M J A M M M A F 04 05 06 E F 07 However, fiscal and tax modifications are not the only ones, but also drastic changes in public policies applied to certain areas. For example, the support to the investment in hydroelectricity, which will allow in the long term to have access to a cheaper energy. This, which goes in the right way, differs from the initiatives in the labour area, that have developed conflicts and increasing costs. Conclusion The grounds of the real exchange rate are anticipating an important downturn during this year. This appraisal of the Chilean peso will affect the real sector. If we want to balance this projection, we have the classic alternatives: more national savings, more efficiency in all the sectors and public policies supporting both alternatives. If we don’t do anything, the TCR destiny for 2008 is already sealed. 4