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The CGD Podcast
What Caused Those Dramatic Emerging Market Currency Dives? – Liliana Rojas-Suarez and Arvind Subramanian
00:25:31
Shutdowns come and shutdowns go. The rest of the world watches Washington’s political antics and scratches its collective head. This Wonkcast was recorded before the current shutdown, when capital was rushing out of emerging markets and back to...
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- [00:08]
A
Welcome back to the Global Prosperity wonkcast. I'm Lawrence MacDonald and we've taken a bit of a break over the summer. It's now fall and I'm delighted to be here in the studio with two of my most valuable colleagues to discuss one of the hottest issues in development economics. Today I'm with Liliana Rojas Suarez. She's a senior fellow here at the center for Global Development and the chair of the Latin America Shadow Financial Regulatory Committee, also known as claf. Liliana, welcome to the show.
- [00:35]
B
Thank you, Lawrence. Glad to be here.
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A
And we also have with us Arvind Subramanian, who's got a joint appointment here at center for Global Development and at the Peterson Institute. Arvind, welcome to the show.
- [00:44]
C
Thanks, Lawrence, for having me.
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A
We've had a couple of very interesting senior staff lunches lately where the topic has inevitably come around to this slide in emergency emerging market currencies, what that might mean for their growth and development, what the causes are and some of the solutions. Inevitably, Liliana and Arvind are extremely persuasive and have different points of view, so I'm delighted to have them here. Liliana, I want to start with you by describing, for those listeners who haven't followed it, what's driving this change? It's a familiar pattern, I think, for those who follow currency movements. But unpack it briefly. What's going on here? Why are the emerging market currencies going down?
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B
Right. First one has to put this in context, right? This is not totally unexpected. The global financial crisis brought a huge expansion of liquidity, global liquidity, not only by the US but also by Europe that everybody knew that eventually it had to be reversed. And that's what is happening now as there are signs of the the US Is starting to recover. There is also signs that an announcement by the Fed that the times of zero interest rates are going to stop and that the so called quantitative easing is also, I mean, the expansionary monetary policy in the US Is going to stop. What does that mean? Well, that means that the investors around the world make a reassessment in their portfolios. Where do I go? Do I go to the more risky emerging markets in search for return or do I now come back to my advanced economy world where I see that risks are coming down while returns are going higher. So this re accommodation of portfolio which is driving the outflows from emerging markets back to developed countries, which of course means pressures on the exchange rates, on the interest rates and on the prospect for growth.
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A
And as you wrote In a blog post on cgd, what this has meant is some pretty dramatic devaluations against the doll. So the rupee, India's rupiah is down about 20%, or at least it was as of last week. May have gone further. The Indonesian rupiah and the Brazil real are both down about 15%. Turkey's lira is down about 10%. Is this a problem? They can just export more, right? Their currencies, they're more competitive.
- [03:07]
B
Good news, right? You know, the question really is not whether they depreciate or not, it's how fast this goes, this depreciation goes. Because certainly the reason why they have the kind of currency exchange rate which is quite flexible, not totally flexible, but quite flexible, is precisely to allow for depreciation. Right. During the 2008, 2009 crisis, there was a huge depreciation of the currencies too. What could hit the economist is that a sudden stop of the inflow that brings a huge depreciation of the currency that actually creates huge currency mismatches between their assets and liabilities. So I'm not concerned about the currencies going back to normal positions. I'm concerned that it's so sudden that they find themselves unable to make good on their external debt obligations.
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A
I want to come to Arvind quickly. But Arvind, I want to ask Liliana one more thing because in her blog post she says what India and others could learn from from a few Latin American countries. And Liliana, you point out that some of the Latins have done a good job in building up reserves. They've begun doing something you call macro prudential regulation, looking at risks across the system, doing counter cyclical capital reserve requirements. Are these the kinds of things that you think could help India to avoid having too sudden of a depreciation?
- [04:28]
B
Well, not now. It's a little bit too late for India now actually. It's funny that you're asking this question because the Central bank of India just started to approve a, what is called a countercyclical provisioning requirement, which basically implies that bans have more reserve to deal with bad shocks. The lesson from these Latin American countries, and actually are not from the large countries, are from countries like Colombia and Peru, is that they have these instruments in place, which means that now, when, if there are problems in the banking system, actually there will be sufficient liquidity for them to deal with those problems.
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A
I want to turn to Arvind. But first I want to do a little bit of a CGD boosting Here to say. Liliana is of course a frequent commentator on CNN Espanol on issues financial, economic in the region. And Arvind, you are regularly published in the Business Standard offering diagnosis and advice to policymakers in India. You're well connected in those circles and recently had a piece in New York Times as well describing what India should do in this situation. Liliana has described what's going on generally across the board. What is it about India's situation that is particularly different from the problems encountered by other nations?
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C
Can we start first with the overall?
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A
Absolutely.
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C
I think one thing we have to recognize is that, you know, when you integrate yourself financially in the form of getting money from abroad, then it cuts both ways. Sometimes when the US advanced countries follow certain policies that leads to a tidal inflow of dollars into emerging market currencies which kind of creates its own pressure. And when the flip happens, which Liliana described, the opposite happens, that currencies start declining, etc. Etc. The problem is that this process is often not smooth, as Liliana said, you get abrupt adjustments in exchange rate which cause problems. But I think the other fact is that these triggers then work on certain fundamental problems in these countries. So it's not as if every country has experienced, every emerging market country has experienced currency problems or financial problems like four or five big ones are experiencing. China is a great example. Its currency actually went up, has gone up. Several Latin American countries have been relatively unscathed, like Mexico. So it's the interaction between what countries do domestically and these external triggers that kind of determines how well or of how fairly you do and how you can adjust against these shocks. Now, India happens to be a case where these external triggers work on fundamentals which are fairly weak. That is, India's problems are much deeper and much more durable and more homegrown, as it were. And that's what I describe in my New York Times piece that, you know, growth from a peak of about 11% even two and a half years ago, it's down to 4.5%. Sharp deceleration in growth. And on top of that, I think amongst emerging market countries, India has been very vulnerable. Fiscal deficit is about 9 to 10% of GDP. Inflation is about 10% of GDP. And over the last two, three years, people have been buying gold as a hedge against uncertainty. And India's, you know, the amount export and the amount in imports has huge imbalances which have to be financed. And that's what created the crisis.
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A
Something that you mentioned in the New York Times piece that really struck me and I think most of our listeners, even if they don't follow these issues closely, will this will resonate for them is the contrast between India's boom which was fed by high skilled labor, call centers, software, back office processing and China's which was low wage manufacturing. And so you have this very large number of people in India who weren't able to participate in they can't write software, they could work in a factory, but there haven't been factory jobs.
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C
Right. So I think there are two things going on here. One is that you know, the fact that India growth momentum has declined. And then what I argue is that perhaps this is kind of the old model based on doing this skill stuff, writing software, creating software, doing these IT services. That model which India was running for about two to three decades and producing reasonably high rates of growth, had run out of steam because even the skilled labor that's required to generate these kinds of services and things, India is not producing them. So what's happened in the last 20 years is that skilled wages in dollars of people who do this has been rising at 10, 12% every year for about 20 years. So India is not even that competitive anymore in these.
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A
You mentioned the Philippines competing with India. I never thought I would hear the day when Philippine wages would be competitive with India.
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C
So on the one hand we're not generating as many jobs, not as competitive and we've never been able to do manufacturing because of all the panoply of regulations that militate against investment in low skill manufacturing. The number I gave in the New York Times piece was that China during the 30, 35 years of its boom, on average the share of manufacturing and GDP has been 34%. India's peaked at 17% and is now down to 14%. So that shows you how good or bad a job India is doing of absorbing all this low skill manufacturing. So the big one big development question, apart from the macro crisis question is how do you generate, how do you create an economy that's going to generate jobs for these low skilled people?
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A
Liliana, does this have any resonance when you look at Latin America? I'm thinking Brazil is the other huge power there. I don't want to put you on the spot in terms of manufacturing, but I guess its boom has been based largely on commodities, agricultural commodities. Does it have a similar kind of problem? Is it more like China or more like India when it comes to this approach or it's its own thing?
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B
Well, I am not sure whether I can make a straight comparison with either of the two countries, but certainly Manufacturing plays a huge role here. I mean, you have to remember, Lawrence, that we've been talking in the past about the problems of depreciation of the real when actually capital inflows were increasing like crazy towards Brazil.
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A
So the real was getting too strong.
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B
That's right.
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A
Hurting export.
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B
Exactly. Hurting its exports and its manufacturing exports. And actually what happened is that the appreciation brought manufacturing down 30%. So actually the depreciation of the currency is actually supporting now the manufacturing sector. We are going that route. But in terms of Brazil and the reason why Brazil has been heated one of the hardest among these emerging market economies has a lot to do with what has been announced by many, many economists for a number of years now. And is that they have an exposure expansionary fiscal policy that have not was okay during the crisis, during the global crisis as a countercyclical policy, you know, to help the economy go back in route in growth. But now they continue doing that and so they never really reversed. And you had political elections problems and all that kind of political.
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A
Sounds like you could be talking about India. I just read Arvind's piece and he says, you know, they're physically expansive and they've kept on being expansive and now they have elections coming.
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B
Right. I think, of course, China is, in its own way. Right.
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A
You have to worry about elections.
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B
Right? Exactly. You don't have to worry about elections. So of course Brazil has to be more comparable to China than to Brazil. Has to be more. Compared to China. To Brazil and India are more comparable as opposed to India, Brazil and China.
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C
Brazil is more comparable to India than it is to China.
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B
That's right.
- [12:22]
A
Well done. Well done. I couldn't untangle that one either, but we know it. Liliana, Minnesota.
- [12:26]
C
But so just to pick up on something that Liliana said that, you know, there seems to be a kind of asymmetry in the way these kind of global markets work. Right. When money was being pushed out of the US and Europe, you know, it just was just chasing returns and investors kind of look less. Look less at risk. So there's kind of an undiscriminating nature when capital pours into emerging market countries. But the asymmetry is that when it comes out, investors seem to be much more discriminating. And in fact, the five emerging market economies that have been most badly hurt, India, Indonesia, Brazil, South Africa and Turkey are in fact those countries which have big external financing problems. That is, their current account deficits have been very high. So because when you have these current account deficits, you need money to Finance that. And that's the power that foreign investors have because they're the guys who are financing these deficits. And so they realize, oh, my God, these guys need the money we're getting out of here. So there's going to be more problems.
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A
A rising tide lifts all boats, but a falling tide leaves some stranded on the rocks.
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C
That's exactly right. And it exposes the ones which, with, I don't know what the right metaphor here would be. Some rocks are more jagged, more jagged than others.
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A
Some land on a sandy bottom and some land on stones.
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C
Exactly. So I think a bit of that's going on here. Of course, I think this raises a bigger question, which is what Liliana and I disagree about, which may be worth going into, is kind of assessing the costs and benefits of being integrated into these global financial markets. And, you know, and I let Liliana say what she has to say. But my. And because it also has lessons or not for other countries in, say, Africa, sub Saharan Africa, for example, because if you look at the outstanding development success of the last 35 years and there's no contest there, it's China, like, you know, 10, half, 10 and a half percent and growth. For 35 years, China has chosen not to integrate itself to global financial markets. Right. And by doing so, it's kept its currency very competitive, very cheap relative to where it should be. It's been an export powerhouse and it's generated rapid growth based on exports, and it doesn't go up and down with the ebb and flow of global finance. So it seems to be a bit like win win for China. Now, obviously it isn't win win, but the question is that why isn't that something that other developing countries should emulate or at least understand why they should not emulate China?
- [15:23]
A
You've raised an excellent question. This is where we should have started the discussion because we have two very eminent economists here, both of you, extremely well informed, and you disagree on this fundamental point of how open to be, how open to financial flows, how open the financial markets should be. And I can't help but be struck that Latin America is the most financially open region and it's done reasonably well by this, although Arvind would say not as well as China. Whereas I think South Asia historically has been rather closed and only in recent decades has begun to be more open. So there's, you know, does this come only from your empirical, your empirical analysis of what works, or is there some sort of deeper predisposition at work here? That's, you don't have to answer that question. But that's the one in my head. Liliana, why should they be open?
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C
No, but one more data point, of course, is that sub Saharan Africa is de facto very, very open to global financial flows, even if they're official.
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A
Liliana, the argument for openness in the financial sector, if that's what you want to make, rebutt.
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B
Arvind okay, first of all, one has to be careful about what we mean by openness. I do not mean that all economies need to open at the same time and without having anything else in mind, but just opening. Okay? Latin America has gone through a process of opening and actually had a number of crises in the process of opening. So we cannot forget that. What I argue for is for the right sequencing of liberalization. And the right sequencing starts first with trade liberalization. First you open trade and you benefit from that. Then you make sure that your domestic financial system is fine and then you start liberalizing your domestic financial system. Once you've done that, you start opening the international capital account, but for long term inflows like foreign direct investment and finally you open for short term capital inflows. If you ask me, can China be open? I would say, I mean from capital accounts, I would say I have no idea because there's no transparency there. How do I know? If you look at, listen to my sequencing, how do I know what is the state of the domestic financial system? If the domestic financial system is weak, and I believe it is, and that's my biggest point of contention here, when I see excessive credit growth, when I see no data coming from the financial system, then I think that it's not ready to be opened. But the problem is that you actually want to emulate a country that is not transparency, that has lack institutions only because it's been growing. Why not address the issue where it's sustainable?
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A
So Liliana has laid out what seems to me to be a very prudent and I would say probably pretty conventional, widely accepted view among economists that it's all about the sequencing and it has to do with timing, but the direction is pretty clear. Do you differ with that, Arvind Would you say that it's not a single direction, that there are multiple paths? Or would you just would your difference with Liliana be about, you know, who's ready and when they're ready? Is there a fundamental difference here in direction or just a difference in assessment of which countries are ready for what actions?
- [18:33]
C
Well, I think there are two issues here. One, I think differences of timing can be Quite significant. For example, sub Saharan Africa. No way it should be so open to capital. I mean, at institutional levels, at levels of development, well before China, well before Latin America, they've been very open. So the question is, why? So even on Liliana's own terms, I think there's a big assessment there about.
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A
Would you agree, Leland, that Africa is quite open? This coming as news to me.
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B
It's getting more open than it was before. But certainly it's not as open as Latin America or Eastern Europe in terms of developing countries.
- [19:11]
C
But one has to be careful here, because if you look at total financial foreign flows, including aid, Africa is very open. And if you look at their policies in terms of how open they are to foreign capital, they're actually very open. It's just that a lot of private capital doesn't come in because people think the opportunities aren't there. But then I think there's the bigger. I think the more fundamental analytical question, which is that my gripe a little bit is that if you hang around Washington long enough, this question always is, oh, yes, integration has benefits, but there are costs, but let's do all we can to maximize the benefits and minimize the cost. What the hell that means, I don't really know. But that's what they always say. But they always come down in favor of, you know, let's keep opening, let's keep opening. I mean, that's the de facto direction in which, you know, the flavor of policy.
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A
Why do you think that is?
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C
And I think it has to do partly with politics, partly with the strength, domestic political strength, of those people who rely on foreign finance. I mean, in the case of India, for example, we've been borrowing dollars. Allowing firms to borrow dollars when it's actually very risky, which even Liliana herself would say, because you create these mismatches between having your assets in rupees and liabilities and dollars, which creates a lot of problems. In India, it happens because there are big companies who want to borrow dollars when borrowing dollars is cheap, even though subsequently it imposes a cost on the rest of the economy.
- [20:47]
A
So you're saying in the case of Washington, it's partly that Washington is marching to Wall Street's drum. Wall street would like to see this liberalization. There's plenty of good income to be heard.
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C
Actually, all of you should, I mean, listeners should read a wonderful piece by Jagdish Bhagwati in Foreign Affairs, 1994. It's called the Capital Myth, and Professor Bhagwati is as free trade as you can get. And he makes the distinction between free trade in widgets and free trade in capital and finance and why there's a fundamental difference. And he says that there is. So I would call this a kind of. He calls it a Wall street treasury complex that pushes finance and foreign finance. And so I think there is a combination of ideology and interests which we've all become enthralled to over time.
- [21:33]
A
What do you think, Liliana? Ideology and interests. Wall street treasury industrial complex.
- [21:38]
B
There is always going to be that in any rules of the games that one chooses. I mean, that's not. That's always going to be an issue. But where I strongly disagree with what Arvin just said about, you know, the goodness of China is that, you know, China has been hurting emerging market economies too. And that is not very much discussed during the time of capital inflows. It's funny that I'm now talking about the time of capital inflows and that was just three months ago.
- [22:13]
C
It changed very soon. The cycle could come back very soon.
- [22:17]
B
Exactly, exactly. So at that time you have all these economies which have chosen more flexible exchange rates and they were following their own rules and therefore the chain were appreciating. Right. The reason why they were appreciating more was because China was not. China was pushing. I mean, the world as a whole, China cannot be insulated. If China didn't appreciate, the other had to appreciate to correct. You know, I mean, something has to adjust. So the fact that China was not adjusting was actually hurting emerging markets. And actually Brazil came very strongly about that point. Right, and the US came very strongly about that point. Okay? So it's not like it's a panacea. And we are always blaming. If we are going to take part of the blame, we should all take it. And I think China has to recognize if is sound blame.
- [23:11]
C
So in fact, I couldn't agree with Liliana more. But this highlights, I think, a central problem in the international system. I think Liliana and I, to summarize, disagree fundamentally on what China did was whether it was good for itself or not. But we fundamentally agree on the fact that what China did for its own good inflicted harm on other countries, that is African countries in India and so on. And I have a paper on that. So the challenge for international cooperation, therefore, is how do you reconcile what may be good at the national level, but may not be good at the international level.
- [23:47]
B
On that I fully agree. The problem is that we are so far to getting into anywhere. You saw the communication of the G20 today I believe in which the BRICs have committed to 100 billion of pool reserve to help each other. And I'm thinking, really to help each other, you're going to travel right out of that 40 billion is coming from China. So it's like pulling reserve. Remember how we were talking about pooling reserve for Latin America? Now the BRICs are proposing to do that. Well, too late. You don't do that in terms of crisis. That's what I think that policies that you put in place should be done before the crisis in lacking international coordination that we all want. But it's not happening. We don't see that movement at all. Well, some at least regional coordination can.
- [24:31]
A
Actually, I think we're going to leave it there. And unlike on previous Wong casts, I'm not even going to attempt to sum this up. I hope that our listeners will find it as much fun and as educational as I did. Thank you both for being on the show. Liliana Rojas Suarez, Senior Fellow at CGD and the Chairman of the Latin America Financial Regulatory Committee, and Arvind Subramanian, Joint Fellow here at CGD and at the Peterton Institute. Thank you both very much.
- [24:55]
B
Thank you, Laurence.
- [24:56]
C
Thanks, Lawrence.
- [24:57]
A
This has been the Global Prosperity Wonkcast from the center for Global Development. You can find the Wonkast online on itunes and on Stitcher. Just search for wonkcast or CGD and subscribe to hear a new interview every week. Or at least now that we're back to the fall. Until next time, I'm Lawrence McDonald. Thanks for listening.