Floating With A Load Of Fx Debt

Countries with de jure floating exchange rate regimes are often reluctant to allow their currencies to float freely in practice. One reason why countries may wish to limit exchange rate volatility is potential negative balance sheet effects due to currency mismatches on the balance sheets of firms and households. In this paper, we show in a sample of 15 emerging market economies that countries with large foreign exchange (FX) debt in the non-financial private sector tend to react more strongly to exchange rate changes using both FX interventions and monetary policy. Thus, our results support the idea that an important source of “fear of floating” is balance sheet currency mismatches. This effect is asymmetric; that is, countries stem depreciation but not appreciation pressure. Moreover, FX debt financed through the domestic banking system is more important for fear of floating than FX debt obtained directly from external sources.

Countries with de jure floating exchange rate regimes are often reluctant to allow their currencies to float freely in practice. One reason why countries may wish to limit exchange rate volatility is potential negative balance sheet effects due to currency mismatches on the balance sheets of firms and households. In this paper, we show in a sample of 15 emerging market economies that countries with large foreign exchange (FX) debt in the non-financial private sector tend to react more strongly to exchange rate changes using both FX interventions and monetary policy. Thus, our results support the idea that an important source of “fear of floating” is balance sheet currency mismatches. This effect is asymmetric; that is, countries stem depreciation but not appreciation pressure. Moreover, FX debt financed through the domestic banking system is more important for fear of floating than FX debt obtained directly from external sources.

There are 13 countries in Central, Eastern and Southeastern Europe (CESEE) with floating exchange rate regimes, de jure. This paper uses the framework pioneered by Frankel and Wei (1994) and extended in Frankel and Wei (2008) to show that most of them have been tracking either the euro or the US dollar in recent years. Eight countries, all of them current or aspiring EU members, track the euro. Of the five countries keying on the US dollar in various degrees, all but one belong to the Commonwealth of Independent States. The paper shows that the extent to which each country’s currency tracks the euro (or the dollar) is correlated with the structure of its external trade and finance. However, some countries appear to track the EUR or USD to an extent which appears inconsistent with inflation targeting, trade or financial integration, or the extent of business cycle synchronization. The phenomenon is particularly pronounced among the countries in the CESEE euro bloc, which may be deliberately gravitating around the euro in anticipation of eventually joining the Euro Area.

This volume engages with the roots, dimensions, and implications of foreign currency domination in states with a national currency. Referred to as unofficial dollarization in literature, this is a worldwide phenomenon among developing countries and has a long history. This monograph provides a political economic analysis of dollarization in Georgia and is structured around three themes: the genesis of dollarization (1991–2003), the persistence of dollarization (2003–12) and the politicization of dollarization (2012–19). The case of Georgia is especially representative of the post-socialist transition states, but also has wider applicability. A high level of dollarization is a significant barrier to economic growth, macroeconomic and political stability, functional monetary policy, as well as social welfare. The Covid-19 crisis and the increasing debt of developing countries in foreign currency exacerbate dollarization-related vulnerabilities for these economies. This book will be of interest to postgraduate students in global/comparative political economy, development economics or transition economies, researchers in monetary sovereignty, central banking, exchange rate policies, currency hierarchy, money, financialization, and policy makers in dollarized countries and global institutions.

The IMF Research Bulletin includes listings of recent IMF Working Papers and Staff Discussion Notes. The research summaries in this issue are “Explaining the Recent Slump in Investment” (Mathieu Bussiere, Laurent Ferrara, and Juliana Milovich) and “The Quest for Stability in the Housing Markets” (Hites Ahir). The Q&A column reviews “Seven Questions on Estimating Monetary Transmission Mechanism in Low-Income Countries” (Bin Grace Li, Christopher Adam, and Andrew Berg). Also included in this issue are updates on the IMF’s official journal, the IMF Economic Review, and recommended readings from IMF Publications.

This Selected Issues paper presents a comparative analysis of the macroeconomic adjustment in Chile, Colombia, and Peru to commodity terms-of-trade shocks. The study is done in two steps: (1) an analysis of the impulse responses of key macroeconomic variables to terms-of-trade shocks and (2) an event study of the adjustment to the recent decline in commodity prices. The experiences of these countries highlight the importance of flexible exchange rates to help with the adjustment to lower commodity prices, and staying vigilant in addressing depreciation pressures on inflation through tightening monetary policies. On the fiscal front, evidence shows that greater fiscal space, like that of Chile and Peru, gives more room for accommodating terms-of-trade shocks.