Transcript Problem of Exchange Rates - International Growth Centre

Using Trade to Grow:
International Lessons (and Questions)
about Exchange Rate Policy for Rwanda
Richard Newfarmer
International Growth Centre
November 1, 2010
This presentation benefitted from research of
Laura Collinson, Economist IGC -Rwanda
Main points…
Rwanda has used donor finance wisely to build its much need
infrastructure, and this has been a driver of growth… but over the
long run Rwanda has to look for additional sources of growth.
One potential growth source is export…but to date trade remains an
under-exploited opportunity for Rwanda – trade ratios for goods are
low, diversification across products and geographic markets is low,
and new exports seem to die quickly
International experience raises questions in several areas that might
merit additional policy discussion (e.g., infrastructure, reducing
trading costs, leveraging regional trade agreements) but one of the
most important is management of real exchange rate.
2
Investment and rising consumption have been major drivers
of recent growth
Contribution to GDP growth
Imports
Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscript
….and development assistance has financed a large
portion of investment…
Source: World Bank, World Development Indicators. HP=16
… reflected in an expansion of services and, within
industry, construction
Composition of GDP Rw$T 2006 prices
Contribution to GDP growth
Services
Services
Industry
Industry
Agriculture
Agriculture
Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscript
Note: The adjustment has been equally divided and incorporated among the three sectors
… reflected in an expansion of services and other
nontradables (with implications for the real exchange rate)
Composition of GDP Rw$T 2006 prices
Contribution to GDP growth
Services
Services
Industry
Industry
Agriculture
Agriculture
But development assistance will eventually wind down..and before that
Rwanda has to look for new sources of growth. Trade is one.
Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscript
Note: The adjustment has been equally divided and incorporated among the three sectors
The EAC countries still have much to gain with trade
integration – trade is below the predicted level
Rwanda trades less in goods than most other countries…
so trade provides an opportunity for growth
Trade as a share of GDP, av. 2007-2008
Qualifications: Services trade is not shown
Informal trade is unrecorded… and
investing in better data is a priority
High performing countries were the fastest-growing in real GDP 1980-2006, and include Botswana, Burkina
Faso, Cambodia, Chile, China, India, Indonesia, Korea, Malaysia, Mauritius, Pakistan, Singapore, Sri-Lanka,
Chinese Tapei, Thailand, and Uganda.
Source: World Bank, World Development Indicators. Average 2007-2008 values. Landlocked represents the
average value across landlocked developing countries excluding Rwanda.
While most fast-growing economies have trade
elasticities over 1.5, Rwanda’s is low even by African
standards
Source: Staff calculations and World Bank, WDI.
Note: considering countries with data for the entire time series. The category “landlocked
developing countries” excluded Rwanda and N=25. Sub-Saharan Africa=30
Rwanda is over-reliant on a few export products…
Source: Staff calculation based on SITC rev3 from Comtrade database
…and this leads to volatility in terms of trade and
undermines sustained growth
Rwanda
Source: World Bank, World Development Indicators.
Exports seem to “die young” …the probability that a
Rwandan export product will survive into future years is
lower than most other countries
1.00
Survival Probability
0.75
Year 2 only 70% of
new products remain
Tanzania
Scope for export
promotion efforts
to sustain
products?
0.25
0.50
Rwanda
0.00
We ran these numbers also with Kenya and Uganda and
other countries, and Rwanda has among the lowest
survival rates
0
5
10
analysis time
Rwanda
Tanzania
Source: IGC staff calculations and WITS comtrade database
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From international experience, four determinants of
success in trade beyond good investment climate…
Infrastructure is a major constraint in most countries
Lowering costs of trading is essential to rapid growth
Regional trade agreements have to be designed to promote
deep integration… otherwise smallest members suffer
Managing the real exchange rate effectively is essential to
maintain competitiveness
In each area, these lessons prompt questions that
Rwandan authorities might want to address…
particularly management of the exchange rate
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Haussman, et al (2004): Five findings about
“growth accelerations”
• First, growth accelerations – an increase in GDP growth rate of 2%+ per
annum and sustained for 8 years -- are quite frequent. …more than 80
episodes since 1950 of rapid acceleration in economic growth that are
sustained for at least eight years.
• Second, growth accelerations tend to be correlated with increases in
investment and trade, and with real exchange rate depreciations.
• Third, political-regime changes are predictors of growth accelerations.
• Fourth, other determinants determine whether the acceleration is sustained
into the longer term or not. External shocks tend to produce growth
accelerations that eventually fizzle out, while economic reform is a
statistically significant predictor of growth accelerations that are sustained.
• Finally, growth accelerations tend to be highly unpredictable: the vast
majority of growth accelerations are unrelated to standard determinants
such as political change and economic reform, and most instances of
economic reform do not produce growth accelerations.
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Management of the real exchange rate: Important to
facilitate export drives
16
Successful export drives have maintained a competitive
real exchange rate…
Impact of 50% Real Undervaluation on GDP per Capita Growth
Impact of 50% Real Undervaluation on Exports to GDP Ratio
Source: Haddad, 2010
17
China is one example of using a competitive real
exchange rate to export and grow…(perhaps to excess)
China: Level of Real Exchange Rate, 1992-2007
(Up = real depreciation)
Source: Eichengreen, 2008
18
…and exchange rate volatility is negatively associated
with GDP p.c. growth…
Volatility (= the absolute value of the percentage change of
the real effective exchange rate of the preceding years)
Source: Eichengreen, 2008
19
…is there room for a better alignment between monetary
and trade –growth objectives?
…Rwanda may wish to undertake its own analysis
20
Global “currency wars” make watching the exchange rate
more important: real exchange rates have shifted
competitiveness since the onset of the Great Recession
…and Rwanda may wish to track these developments to anticipate
external exchange rate surprises
Source: J.P. Morgan, October 21, 2010
Conclusions…
Rwanda’s objective of using trade to power growth is well-formulated
…and the government has identified all the right issues… from
infrastructure to trading costs to regional integration.
But price incentives will determine success or failure of any export
drive…
…and arguably the most important price in the economy is the rate of
foreign exchange. Hence understanding the recent historical role of
exchange rate determination and exploring ways the government
might maintain a competitive real effective exchange rate –
especially in light of a prospective EAC monetary union -- is crucial.
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The IGC Program in Tanzania: Towards Monetary
Integration
Joint research plan for monetary union developed by Monetary Affairs Committee
of the East African Community. Bank of Tanzania / IGC-T lead agency on:
–Exchange rate regimes and convergence
–Monetary transmission mechanism
–Money demand
Money and Monetary Policy Issues
• BoT--along with rest of EAC –targets inflation using a monetary anchor
(M2), with reserve money as the operational target but RM programs might
be losing effectiveness
Research Papers
• Money demand [complete –on line ]
• Liquidity management and the money multiplier [complete –final review]
• Dollarization and currency substitution [complete –final review]
• Food prices and the dynamics of inflation in Tanzania [in progress]
• Financial architecture and the monetary transmission mechanism [2010 Q4]
The IGC would be pleased to sponsor a greater
participation of BNR in this research
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References cited
Aghion, Philippe, Philippe Bacchetta, Romain Ranciere and Kenneth Rogoff, 2006.
Exchange Rate Volatility and Productivity Growth: The Role of Financial Development.
NBER Working Paper No. 12117.
Eichengreen, Barry, 2008. The Real Exchange Rate and Economic Growth. Commission
on Growth and Development. World Bank: Washington, DC
Haddad M., and C. Pancaro, 2010. Can Real Exchange Rate Undervaluation Boost Exports
and Growth in Developing Countries? Yes, But Not for Long. Economic Premise No. 20.
World Bank, Washington, DC
International Monetary Fund (IMF), 2010. Rwanda: Request for a Three-Year Policy
Support Instrument. IMF: Washington DC
Hausmann, Ricardo, Lant Pritchett, and Dani Rodrik, 2004. Growth Accelerations. NBER
Working Paper No. W10566.
Levy Yetati, Federico Sturzenegger Eduardo and I. Reggio, 2003. On the Endogeneity of
Exchange Rate Regimes. Unpublished manuscript, Universidad di Tella.
Spence, Michael. 2008. The Growth Report: Strategies for Sustained Growth and Inclusive
Development. Commission on Growth and Development. World Bank: Washington, DC
Winters, L. Alan, 2004. Trade Liberalization and Economic Performance: An Overview. The
Economic Journal, 114 (February): Oxford
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Using Trade to Grow:
International Lessons (and Questions)
about Exchange Rate Policy for Rwanda
Richard Newfarmer
International Growth Centre
November 1, 2010
This presentation benefitted from research of
Laura Collinson, Economist IGC -Rwanda