Higher interest rates by US Fed hits developing countries currencies.

Contractionary monetary policy by the US Federal Reserve to keep inflation in-check has impacted African currencies. With higher interest rates in the US and a volatile global environment investors tend to run to the safety of the US dollar and higher paying US treasury bonds. This has led to a depreciation in African currencies and inflation as import prices increase. For most African countries more that 60% of imports are priced in US dollars and a 1% depreciation against the US dollar = an average of 0.22% increase in inflation.

The graph below from the IMF shows the extent of the depreciation. Two countries’ currencies depreciated by more than 45% – Ghana and Sierra Leone. Some central banks have used their supply of foreign reserves in an attempt to prop up their currencies – giving foreign exchange to importers.

Weaker currencies push up debt – approximately 24% of public debt in most African countries in denominated in US dollars so with a weaker currency they have to find more of their currency to pay back the US dollars. Furthermore, the weaker currency has meant that public debt has risen on average by 10% of GDP in the region. Below is a mindmap showing the impacts of a falling currency.

Source: IMF Blog

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Climate change: who is helping developing countries

Poor nations, which have contributed the least to climate change are among the most vulnerable to climate change today. They need some financial commitments from the developed world who have grown their economies by polluting the atmosphere. For instance Pakistan emits under 1% of global emissions but it is the eighth most vulnerable country – see graphic. It is estimated that Pakistan has had $22 billion in material damages with up to 12,000 people losing their lives with 60 million affected – 2022 saw extreme monsoon rains and the worst flooding in a decade.

It is the developed world that is most responsible for climate change – since 1850 the US has emitted more than 500 billion tonnes of CO2 which is approximately twice that of the next largest emitter China. It is vital that the richer countries assist the developing world combat extreme weather. They have the finance to do it but don’t seem to rich their target of $100bn per year year since 2020. There is a pay back here in that those got countries got rich on the problem that we now have.

1992 UN Framework Convention of Climate Change was approved and at the Conference of Parties (known as COP) and in 2009 15 developed nations committee to $100 billion each year – see graphic – to support developing countries with reducing emissions and adapting climate change. The $100 billion goal was “carefully crafted” to be deliberately vague. As a result, there’s no requirement that specific countries contribute a certain proportion of the funds. Multiple analysis have calculated that the United States, which contributed less than $3 billion of the $83.3 billion in 2020, is under delivering by tens of billions of dollars when considering its relative emissions, population size and wealth.

The IMF has also provided long-term affordable financing. The money so far has funded mitigation projects, which help developing countries transition away from fossil fuels, like building a zero-emissions transit system in Pakistan. Money has also gone toward adaptation projects, which help countries build resilience against climate risks, like restoring vegetation and reducing the risk of flooding.

Source: New York Times. Who will pay for Climate Change. Nov 7 2022

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Difference between the IMF and the World Bank

Updating the new CIE AS and A Level syllabus for 2023 and external debt and the role of IMF and World Bank are part of Unit 11 of CIE A2 syllabus. This is an area where students get confused as to the role of each organisation.

The International Monetary Fund (IMF) (http://www.imf.org) promotes international financial stability of the world’s monetary system. Lends to countries with balance of payments problems and aims to promote development by restoring short run stability and by supporting long term adjustment and reform

The World Bank (http://www.worldbank.org) promotes institutional, structural and social development by providing low interest loans and technical assistance for domestic investment projects. It’s goal is to reduce poverty by offering assistance to middle-income and low-income countries. It aims to help countries meet the UN Millennium Development Goals.

Below is a useful video from CNBC on the differences.

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UK Pound slumps as IMF advises against tax cuts

Below is a very good video from Al Jazeera that explains the Bank of England’s emergency intervention to calm the market after the UK’s government’s tax cut plans. Once these plans were announced the GB Pound slumped to it lowest level $1.035 against the US Dollar since 1985. The BoE announced it is buying up long-dated UK government bonds to bring stability to financial markets but even higher interest rates are still likely and that is worrying news for the country’s property market. Good coverage of this below from Al Jazeera.

IMF: SDR’s and poor countries

When teaching development economics most courses reference special drawing rights (SDR) from the IMF to assist both developing and developed countries. SDR was created in the 1960’s and is a part currency consisting of reserve assets such as dollars and gold. They are valued against a basket of several major currencies and can be swapped for those currencies. Unlike a lot of loans there are no conditions with SDR’s and the interest rate is only 0.05% with no payment deadline.

Since COVID-19 the IMF has assisted countries as follows:

  • extended loans worth about $130bn to 85 countries
  • provided debt-service relief to some poor economies
  • created $650bn in new foreign-exchange reserves

The important aspect about this is that the availability of these reserves should lift market confidence and put less pressure on a country’s foreign currency reserves. The IMF estimates that the global economy will be short of reserve assets of 1.1 to 1.9 trillion.

Why are SDR’s useful for countries

Assuming there is a recovery in the USA this will lead to higher interest rates and money will leave predominately poorer countries to take advantage of the higher return. This will weaken those domestic currencies which in turn make imports more expensive. The new allocation of SDRs will give governments the finance to import essentials like food and vaccines – see graphic.

The more you give the more you get.

The new distribution of SDR’s equates to the proportion of funding that a country provides to the IMF which means that more developed countries will receive more than half the quota. Low income countries get 3.2% or $21bn of the total which seems to be insufficient to cope with public health issues caused by COVID-19 as well as climate change and an economic recovery. Furthermore, more developed countries have greater ability to borrow on global markets than those less developed. However, richer countries are looking at ways of donating some of their new SDRs to poorer nations with contributions of about $15bn in existing SDR holdings have already helped expand an IMF facility offering no-interest loans to poor countries over the past year.

Source: The Economist -Every little helps – 17th July 2021

IMF World Evaluation from the FT

Below is a very good video put together by the FT which summarises the recent IMF Report on the World Economy. Includes:

  • Better growth in China and the Euro zone makes up for slow US growth.
  • US infrastructure spending and tax reform still has to be approved by the senate.
  • Europe looking stronger than expected.
  • Emerging economies still face tough conditions.

Aussie dollar – Pacific Peso to Swiss Franc of the South

A little over a decade ago the Australian dollar was being dismissed as the Pacific Peso but today some are referring to it as the Swiss Franc of the south. This is an indication of its safe-haven status as central banks worldwide start to diversify their reserves away from US dollars and Euros into Aussie dollars.

The IMF recently announced that they intend to make the Australian dollar and Canadian dollar Global Reserve Currencies. Both will be included in the COFER (Currency Composition of Official Foreign Exchange Reserves) surveys, which currently consists of the:

U.S. dollar
Swiss franc
pound sterling
Japanese yen.

The IMF is asking member countries from next year to include the Australian and Canadian dollar in statistics supplied by reserve-holding nations on the make-up of their central banks’ foreign exchange reserves. In previous years the world has had just two reserve currencies:

1. Sterling up to 1914
2. US dollar since the WWI

Notice the drop in the Australian dollar during the start of the financial crisis but its strengthening since 2009. Australia is just one of only seven countries in the world with a AAA-rating from all three global credit ratings agencies – Moodys, Standard & Poors, and Fitch.

Emerging v Developed: Changing of the Guard

The Economist recently focused on the significance of emerging countries over developed countries – a useful article for the Development Economics part of the Cambridge A2 course. As output in most of the developed world contracts, amidst the pressure of austerity measures, those economies that are less developed or emerging have seen the output increase by approximately 20%. Nevertheless how big are emerging markets relative to the developed world?

As successful emerging economies graduate to developed status the prevalence of the emerging economies is eroded. Therefore to appreciate the true shift in global economic power, The Economist looked at numbers using the IMF’s pre-1977 classification. Developed economies based on 1990 data: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom, United States. Newly industrialised countries such as South Korea count as emerging.

From the graph below you can see that the combined output of emerging countries accounted for 38% of world GDP in 2010 twice its share in 1990. If GDP was measured at purchasing-power parity, emerging economies overtook the developed world in 2008 and are likely to reach 54% of world GDP this year. Other key indicators are:

– in 2010 emerging economies accounted for over 50% of world exports
– in 2010 they accounted for over 47% of world imports – domestic demand up markedly
– they attracted over 50% of world foreign direct investment (FDI).
– they consume 60% of world energy, 65% of copper, 75% of steel, 55% of oil
– they make up 46% of world retail sales, 52% of purchases of new cars, and 82% of mobile-phone subscriptions

But maybe more importantly emerging economies are only responsible for 17% of all outstanding debt – one indicator that you don’t want to at the top. With less debt, a growing middle class and huge potential to lift productivity, emerging economies will become the drivers of global growth.

Lagarde IMF head – number 12 from Europe

France’s Christine Lagarde was named the new head of the International Monetary Fund at a critical time for that organization and for the global economy. Historically the IMF’s managing director has been European and the president of the World Bank has been from the United States – currently Robert Zoelick former US Deputy Secretary of State. Below is a clip from PBS Newshour where Judy Woodruff discusses what kind of challenges she faces with Cornell University’s Esward Prasad and George Washington University’s Scheherazade Rehman. There is also good coverage of what the IMF does which is useful for those A2 students.

One, it lends money to countries in trouble. But, more importantly in the new world economy, what it does is, it tells countries what they should be doing with their policies. It evaluates their financial systems. It evaluates their policies, talks about whether those policies are good for the country, but, more importantly, also for the global economy, what is, somewhat strangely, called surveillance.

A new global reserve currency?

Dominque Straus-Kahn, the managing director of the IMF, has signaled the recommendation of a new global currency. Member countries hold with the IMF reserves that are referred to as Special Drawing Rights (SDR). His intention is the SDR could act as an alternative to the US$ in central banks’ foreign currency reserves.

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204 billion (equivalent to about $308 billion, converted using the rate of August 31, 2010). SDR’s are based on a basket of currencies – US$, £, €, ¥ – and should be broadened to include the Chinese Yuan.

Using the SDR would act as a safeguard from exchange rate volatility while issuing SDR-denominated bonds could create a potentially new class of reserve assets.

International policy makers have become increasingly concerned about the threat of currency wars. This is where governments have been trying to reduce the value of their currency to increase the competitiveness of their exports and claw its way out of recession.

NZ debt – the good news and the bad news

Despite a glowing report from the IMF which stated that New Zealand has the second smallest government debt among 23 developed countries, credit rating agency Standard and Poor’s (S&P) has indicated that the overall level of debt has the country vulnerable. Treasury estimate govenment debt to be 27% of GDP by 2015 but this compares to total net debt at 90% of GDP with much of this in the private sector.
Their concern is that if there is a major budget crisis in other countries this could make markets nervous about investing in high debt economies – both government and private debt. New Zealand is borrowing up to $240 millilon dollars a week and if the former were to happen interest charges on that borowing would go up (maybe a downgrade by credit rating agencies) which ultimately would effect growth in the economy and the NZ$. S&P suggest that there is a need to rely less on foreign funds and generate more export revenue especially from the Asian markets. The balancing act is making sure that debt as a % of GDP doesn’t get too high but at the same time generating growth in the economy. Click here for Brian Fallow’s column in the NZ Hearld.