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									Global Economic Prospects June 2012                                                                                                                        Exchange Rates Annex

                                                                      Exchange Rates

 Recent developments                                                                              in early 2012 when the (partial) relaxation of
                                                                                                  tensions in high-income Europe and the
 In the year to the first week of June, the US                                                    stabilization of global financial markets resulted
 dollar strengthened from 1.44 to 1.25 per euro,                                                  in falling investors’ risk aversion. As a result,
 with the bulk of the appreciation occurring post                                                 during the first two months of 2012, the trade-
 July 2011 as the nominal (and real) trade                                                        weighted real effective exchange rates of Brazil,
 weighted US dollar appreciated by 6 percent,                                                     Turkey, India and South Africa appreciated by 5
 largely reflecting the US dollar’s safe-haven                                                    percent or more, while higher international
 status at the onset of the Euro Area crisis and the                                              commodity prices boosted the currencies of
 flight to quality that ensued. To a large extent,                                                commodity exporters including Chile, Colombia
 these developments have also been mirrored in                                                    and Mexico. With resumption of Euro Area
 emerging market currencies as developments in                                                    uncertainties since early May and flight of
 the US dollar continues to be a major                                                            private capital to safer US financial assets — and
 determinant of both the value and volatility of                                                  weakening of commodity prices for commodity
 emerging market currencies. But it is important
                                                                                                   Figure ExR.2 Generalized appreciation of US dollar
 to realize that in spite of the US dollar’s safe                                                  relative to emerging market currencies
 haven status, the average real trade weighted
 emerging market currency has been less volatile                                                   Inverted local currency/US$, Index, Jan. 1, 2012=100
 than the real US dollar trade weighted exchange
 rate almost 70 percent of the time over the last                                                 110

 10 years (figure ExR.1).1

 Even so, and despite the improvement in
 developing countries’ relative macroeconomic
 fundamentals vis-à-vis the U.S., some of the                                                      95
 larger emerging currencies still came under                                                                                 Brazil                       China

 significant pressure at the onset of the Euro Area                                                90
 debt crisis in the second half of 2011. Likewise,                                                                           Turkey                       South Africa

 partly because of the liquidity generated by very                                                 85
                                                                                                    Jan-12              Feb-12           Mar-12            Apr-12                 May-12        Jun-12

 loose monetary policy in high-income countries                                                    Source: IMF International Financial Statistics, Data-
 several large financially-open emerging market                                                    stream and World Bank.
 countries experienced a a surge in foreign capital
 Figure ExR.1 In real-effective terms developing currencies have been much less volatile than viz-à-viz the US dol-
 Inverted USD exchange rates, index average 2005=100                                               Real-effective exchange rate, index average 2000-2005=100

 150                                                                                              210


  90                                                                                              110

               India   Indonesia   South Africa     Russia   Brazil   Turkey     China                          India      Indonesia      South Africa      Russia       Brazil      Turkey   China
  50                                                                                               50
    Jan-05    Jan-06     Jan-07     Jan-08        Jan-09     Jan-10     Jan-11      Jan-12          Jan-05      Jan-06       Jan-07        Jan-08        Jan-09      Jan-10          Jan-11    Jan-12

 Source: IMF International Financial Statistics, J.P. Morgan, and World Bank.

Global Economic Prospects June 2012                                                                                     Exchange Rates Annex

 exporting developing countries — the US dollar             Figure ExR.3 Developing countries' real exchange
                                                            rates appreciated between 2003 and 2011
 again experienced a generalized appreciation
 with respect to emerging market currencies                 Real effective exchange rate, average (Jan. 2003=100)

 (figure ExR.2). Although central bank                      135

 intervention in foreign exchange markets briefly           130

 halted the slide in the Brazilian real in late May,        125
 other emerging market currencies showed signs              120
 of appreciation in early June, encouraged by
 expectations of coordinated official actions to                                                                                  Developing
 deal with the ailing Spanish banking sector,               110                                                                   Developing excl. China
 reduction in borrowing costs in China, and                 105
                                                                                                                                  Linear (Developing)
 possibility of further stimulus measures.                  100
                                                                                                                                  Linear (Developing excl. China)
                                                                                                                                  Linear (High-income)
 Moreover, partly as a consequence of the                    95
 broader appreciation of the US dollar,
 developing countries’ currencies measured
 against a wider range of currencies have










 depreciated less than against the US dollar in
 recent months.
                                                            Source: IMF International Financial Statistics, J. P. Mor-
                                                            gan, and World Bank.
 While cyclical factors have played a role, to a
 large extent the appreciation of the currencies of
 many of the larger middle-income countries                   increases compared with high income countries.
 during the last decade has reflected long-term               Developing countries’ average annual real GDP
 fundamental factors including large changes in               growth accelerated from 3.8 percent during 1994
 commodity prices, productivity differentials and             -2002 to 6.4 percent over 2003-11. In the same
 in some cases domestic policy.                               two periods, high income countries’ average
                                                              growth declined from 2.8 percent to 1.6 percent.
 Exchange rates over the medium-term                          Furthermore, developing countries’ total factor
                                                              productivity (TFP) rose 2.2 percent annually on
 Developing countries’ real exchange rates                    average during this period, more than double the
 have appreciated since 2003, with return to                  rate of increase for high income countries. Other
 trend following crisis                                       factors at play include improved macroeconomic
                                                              management in many developing countries, high
 In general, developing countries’ average trade-             commodity prices (in commodity exporting
 weighted real effective exchange rates have been             countries), and sustained inflows of private
 appreciating more or less steadily since 2003,               capital and remittances in several middle- and
 even as high income countries’ real exchange                 low-income countries. Importantly, the strong
 rates depreciated (figure ExR.3). The average                appreciation of developing country currencies
 GDP weighted real exchange rate of developing                after the Lehman crisis in 2008 mainly reflects a
 countries (excluding China) appreciated by a                 return to pre-crisis levels and trend appreciation
 cumulative 25.7 percent (26.7 percent) between               in line with underlying fundamentals – rather
 2003 and the first quarter of 2012, or by about              than a significant deviation from earlier trends.
 2.6 percent (2.7 percent) annually, in spite of
 significant real depreciations during the Lehman             Rising commodity prices until April
 crisis in 2008 and during the Euro Area                      supported commodity exporting currencies
 sovereign debt crisis in late 2011.
                                                              Most commodity exporting countries have
 In general, the positive trend in developing                 experienced (often significant) gains in their
 countries’ currencies since 2003 reflects a faster           terms of trade as commodity prices rose sharply
 pace of growth and higher rate of productivity               over the past decade. These improvements have

Global Economic Prospects June 2012                                                                                                                                              Exchange Rates Annex

 Figure ExR.4 Real exchange rates of commodity exporters appreciated as their terms of trade improved with in-
 crease in international commodity prices up until April

                                    Brazil                                                                  Colombia                                                               Nigeria
 Index (Jan 2005=100)                                     Index (Jan 2005=100)     Index (Jan 2005=100)                           Index (Jan 2005=100)    Index (Jan 2005=100)                        Index (Jan 2005=100)
   220                                                                       120     150                                                           140      160                                                          220

  200                                                                               140                                                                                                                                  200
                                                                                                                                                   130     150
  180                                                                               130
                                                                                                                                                   120     140
                                                                             100                                                                                                                                         160
  160                                                                               120
                                                                                                                                                   110     130                                                           140
  140                                                                        90     110
                                                                                                                                                   100     120
  120                                                                               100
                                               REER                          80                                              REER                                                               REER [left]
  100                                                                                90
                                                                                                                                                   90      110
                                               Terms of trade [right]                                                     Terms of trade [right]                                                Terms of trade [right]
   80                                                     70                         80                                                          80        100                                                     60
    Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12                           Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12                Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12

                                    Mexico                                                                     Russia                                                            South Africa
 Index (Jan 2005=100)                                     Index (Jan 2005=100)   Index (Jan 2005=100)                              Index (Jan 2005=100) Index (Jan 2005=100)                          Index (Jan 2005=100)
 115                                                                         120 150                                                                180 120                                                              120
 110                                                                                                                                                       110
                                                                                    140                                                             160                                                                  100
                                                                                                                                                    150 100
 100                                                                                130
                                                                             100                                                                                                                                         80
  95                                                                                                                                                130     90
  90                                                                                                                                                120     80
                                                                             90                                                                                                                                          60
  85                                                                                110
                                                                                                                                                    100     70
  80                                                                         80                                                                                                                                          40
                                                   REER                             100                                   REER                      90                                        REER
  75                                                                                                                      Terms of trade [right]    80
                                                   Terms of trade [right]                                                                                                                     Terms of trade [right]
  70                                                                         70      90                                                     70              50                                                     20
   Apr-05   Apr-06      Apr-07   Apr-08   Apr-09    Apr-10    Apr-11    Apr-12        Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12                Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12

 Source: IMF International Financial Statistics, J. P. Morgan, and World Bank.

 been reflected to varying degrees in real                                                                               income commodity exporters. For instance, after
 exchange rates – depending on the extent to                                                                             experiencing a steep depreciation in the second
 which the authorities have allowed the nominal                                                                          half of 2011, Brazil’s trade weighted real
 exchange rate to appreciate (or depreciate) in                                                                          exchange rate appreciated 5.2 percent between
 response to international commodity price                                                                               December 2011 and February 2012 due to the
 shocks. For instance, South Africa’s flexible                                                                           combined effect of high commodity prices and a
 exchange rate regime has allowed the real                                                                               surge in capital inflows. But measures to stem
 exchange rate to move closely with its terms of                                                                         the currency appreciation, including extension of
 trade, with the nominal exchange rate acting as                                                                         taxes on cross-border borrowing by local firms
 the economy’s main shock absorber and                                                                                   to shorter-maturity loans, resulted in a
 automatic stabilizer. This phenomenon was also                                                                          substantial nominal and real depreciation. Real
 observed to a more or lesser extent in other oil                                                                        exchange rates of commodity exporters with a
 and commodity exporting countries such as                                                                               significant manufacturing export sector have also
 Brazil, Colombia, Nigeria, Mexico and Russia                                                                            been influenced by developments in trade
 (figure ExR.4).                                                                                                         partner countries. Mexico’s trade-weighted real
                                                                                                                         effective exchange rate depreciated steeply
 Notwithstanding their access to commodity                                                                               during the Euro Area debt crisis in late 2011
 resources, exchange rates in these countries are                                                                        similar to that of other financially integrated
 not only exposed to volatile commodity markets,                                                                         emerging markets; but it then appreciated 7.6
 but this currency volatility is often exaggerated                                                                       percent in the first quarter of 2012 as
 by commodity related capital flows—                                                                                     strengthening demand and better employment
 particularly for the larger, more open middle

Global Economic Prospects June 2012                                                    Exchange Rates Annex

 outturns in the U.S., its largest trade partner,          sovereign and corporate balance sheets (Ostry
 translated into improved domestic prospects.              and others 2011).

 There is a widely held perception that the                To the extent that shorter-term currency
 exchange rates of many commodity exporting                movements are driven by (identifiable)
 countries are extremely volatile. However, these          speculative capital flows that are temporary in
 currencies are merely reflecting the underlying           nature, there could be a rationale for ―leaning
 volatility of commodity prices. Although adverse          against the wind‖. Some forms of controls on
 exchange rate movements (and volatility) are              foreign currency capital inflows or outflows and
 often painful to domestic industry in these               other prudential regulations may be justified in
 countries, the (volatile) exchange rates often act        the shorter-term to reduce excessive exchange
 as an automatic shock absorber and stabilizer.            rate volatility and to provide space for domestic
                                                           manufacturers to adjust to a changing economic
 Capital flows are an important driver of                  environment.
 short-term movements in emerging market
 currencies                                                There is a risk, however, that such short-term
                                                           measures may become ―sticky‖, and over time
 Capital flows continue to be a driver of short-           introduce distortions in production and capital
 term movements in nominal and real exchange               allocation decisions, thereby hurting longer-term
 rates. The rapid withdrawal of foreign capital            growth prospects. Capital flow management
 during the Euro Area sovereign debt crisis in the         measures should therefore be reviewed regularly,
 second half of 2011 from several emerging                 and capital controls should be adapted or
 markets (including from some commodity                    reversed as destabilizing pressures abate (G20
 exporters) appears to have contributed to a steep         2011). In particular, capital flow management
 depreciation of their currencies, but the                 measures should not be used to avoid or unduly
 resumption of capital inflows contributed to              delay necessary adjustments in the economy.
 appreciation of emerging market currencies,
 including those of Brazil, Turkey, and India in           Commodity importing countries’ real
 the first quarter of 2012.                                exchange rates depreciated as commodity
                                                           prices rose up until April
 Permanent increases in the underlying capital
 inflows (such as capital inflows responding to            Several net oil- and commodity-importing
 faster potential growth) to a developing country          countries experienced terms of trade losses and
 are likely to result in currency appreciation and         real exchange rate depreciation as the increase in
 vice versa. Apart from a once-off adjustment to           imported commodities prices outpaced
 the new equilibrium capital inflows, this should          manufacturing export prices. Real currency
 not raise currency volatility. When capital flows         depreciation appears to have been more
 are relatively permanent in nature and are likely         pronounced in countries with relatively weaker
 to contribute to increasing productivity and              current account positions – which were more
 longer-term growth, there is little rationale for         exposed to foreign capital, such as India and
 policymakers to intervene or restrict these flows.        Turkey (figure ExR.5). Currencies of several net
                                                           oil-importing Sub-Saharan African and South
 However, when these inflows are more related to           Asian countries have faced depreciation
 speculative ―hot money‖ flows, the flows can be           pressures due to a combination of rising burden
 disruptive. Such hot money inflows can                    of energy imports amid strong economic growth.
 potentially erode competitiveness, albeit                 For instance, Bangladesh and Pakistan have
 temporarily, and could give rise to credit and            faced current account pressures and nominal
 asset price booms. Rapid withdrawals of such              depreciation due to a rising import bill from high
 flows and the resulting nominal depreciation can          international prices of crude oil imports and
 increase the burden of foreign currency debt on           relatively weak export growth.

Global Economic Prospects June 2012                                                                                                   Exchange Rates Annex

 Figure ExR.5 Terms of trade losses and real                                          Figure ExR.6 Oil- and commodity-importing
 exchange rate depreciation in India and Turkey                                       developing countries experienced larger real
                                                                                      depreciation during recent crises
                                                                                      Real effective exchange rate appreciation (%)
  Index (Jan 2005=100)                                   Index (Jan 2005=100)
    115                                                                    100
   100                                                                                 -8
                                                                                                                                         July-Dec 2008
    95                                                                                -10
                                                                           75                                                            July-Dec 2011
    90            REER
                  Terms of trade [right]                                              -14
    85                                                                     65                     Developing oil-importers             Developing oil-exporters
     Apr-05   Apr-06     Apr-07   Apr-08   Apr-09   Apr-10   Apr-11   Apr-12
                                                                                      Real effective exchange rate appreciation (%)
                                   Turkey                                               4
  Index (Jan 2005=100)                                   Index (Jan 2005=100)
    115                                                                    120          2

   110                                                                     110          0

                                                                           100         -2

                                                                                       -6                                               July-Dec 2008
    90                                                                                                                                  July-Dec 2011
                 REER                                                      70
                 Terms of trade [right]                                               -10
    80                                                                     60                         Other developing                 Commodity-rich developing
     Apr-05   Apr-06     Apr-07   Apr-08   Apr-09   Apr-10   Apr-11   Apr-12
                                                                                      Note: Charts exclude China
 Sources: IMF International Financial Statistics, J. P. Mor-                          Sources: IMF International Financial Statistics, J. P. Mor-
 gan, and World Bank.                                                                 gan, and World Bank.

 Net oil and commodity importing developing                                           Prospects for                          developing            countries’
 countries as a group experienced significantly                                       exchange rates
 larger depreciations during recent crises
 compared to oil exporters. The GDP-weighted                                          Developing countries’ currencies are likely
 average real exchange rate of oil importing                                          to appreciate in the longer term, but remain
 countries excluding China depreciated 12.2                                           under pressure in the near term
 percent during the Lehman crisis in the second
 half of 2008 and 6.1 percent during the Euro                                         Exchange rates are extremely difficult to forecast
 Area debt crisis in the second half of 2011,                                         over the short run. However, in the longer term,
 compared to 3.2 percent and 1.4 percent                                              as discussed earlier—with a relatively weak
 declines, respectively, for oil exporting                                            growth outlook in high income countries,
 developing countries (figure ExR.6). Even as                                         continuation of improvement in developing
 commodity exporters gained from high prices up                                       countries’ fundamentals, superior growth and
 until April 2012, oil and commodity importing                                        total factor productivity differentials—
 developing countries, in particular those that are                                   developing countries real appreciation is
 relatively open to foreign capital and have                                          expected to continue, albeit at a slower rate.
 weaker current account positions, have faced
 renewed depreciation pressures with resumption                                       The discussion above suggests that the future
 of Euro Area tensions.                                                               path of developing countries’ currencies will

Global Economic Prospects June 2012                                                                                          Exchange Rates Annex

 depend on capital flows, commodity prices, and            Figure ExR.7 Current account surpluses have fallen
 most importantly, relative productivity increases.        and deficits widened in developing regions
 Some developing countries currencies benefited             Current account balance as a share of developing countries' GDP, Percent
 from falling risk aversion and a surge in capital           4.0
 inflows in early 2012, partly reversing earlier             3.5

 depreciation, as loose monetary policies and                3.0

 lower relative yields in high income countries              2.5

 generated renewed interest in emerging market               2.0

 assets.                                                     1.5


 Going forward, however, developing countries’               0.5

 currencies could come under even greater
 pressure if current Euro Area tensions escalate            -1.0
 and private capital flows become more volatile;                       2003        2004     2005         2006     2007       2008    2009     2010     2011     2012

 if the pace of European banking sector                          China                                   EAP excl. China                    Europe & Central Asia
                                                                 Latin America & Caribbean               Middle East & N. Africa            South Asia
 deleveraging accelerates (see Finance Annex);                   Sub-Saharan Africa

 and if the US dollar continues to appreciate with
 respect to emerging market currencies given its           Source: World Bank.
 safe haven status. Commodity exporting
 countries’ currencies gained from high                    Figure ExR.8 Reserve cover has fallen in more than 75
                                                           percent of middle-income developing countries since
 international prices in early 2012, but weakening         January 2010
 global demand and the resulting lower                        Percent change in international reserves in months of mechandise imports
 commodity prices are leading to depreciation                           Angola
 pressures. On the other hand, commodity                           Philippines
 importers among developing countries could                             Mexico
 also face worsening trade and current account                             Peru
 positions if weak global demand keeps                                    Brazil
 manufacturing exports below the longer term                        Indonesia
 trend. Moreover, renewed geopolitical tensions                     Paraguay
 in the Strait of Hormuz could result in a spike in                      China
                                                               Moldova, Rep.
 crude oil prices, further exacerbating strains on                   Romania
                                                                 South Africa
 oil importing countries.                                              Zambia
                                                                      Pakistan                                                        % Increase between
                                                           Dominican Republic                                                         Jan. 2010 and MRV
 Current account and trade balances of                             Azerbaijan
 developing regions have deteriorated in recent                         Bolivia
 years (figure ExR.7), in large measure due to the                   Colombia
 decline in East Asia and Pacific region’s current                      Turkey
 account surplus. China’s surplus fell from over                     Lithuania
 10 percent of GDP in 2007 to 2.8 percent in                         Sri Lanka
                                                           Russian Federation
 2011, reflecting weakening export demand and a                       Vietnam
 shift towards domestic sources of growth, which                  Kazakhstan
 has resulted in imports growing faster than                            Gabon
 exports. In other developing regions, however,                           India
                                                                 Yemen, Rep.
 widening trade deficits and deteriorating current                 Cameroon
 account balances, especially in commodity- and                          Latvia
 oil-importing countries, suggest that developing                       Jordan
 countries’ exchange rates are likely to remain               Venezuela, RB
                                                             Egypt, Arab Rep.
 under strain. International reserves expressed as                             -80        -60      -40      -20          0      20     40        60      80         100
 share of merchandise imports fell in 76 percent           Note: MRV = Most recent value
 of middle-income developing countries between             Source: IMF International Financial Statistics and World

Global Economic Prospects June 2012                                               Exchange Rates Annex

 January 2010 and the most recent available date            policies.‖ Working Paper 17363, NBER:
 in 2012, by 26 percent on average (figure                  Cambridge MA.
 ExR.8). Reduced international reserves available
 for meeting short term obligations can increase           Williamson, J. 2008. ―Exchange Rate
 vulnerability of developing countries to external          Economics.‖ Open Economy Review, Vol. 20,
 shocks, in particular if external financing                pp.123-146
 conditions were to deteriorate further and capital
 flows retreat.

 In the longer term, real exchange rates of
 developing countries are likely to revert to the
 upward trend. Developing countries will need to
 learn to live with real currency appreciation and
 instead focus on maintaining favorable
 productivity trends and competitiveness.
 Developing countries with relatively good
 growth prospects will need to adapt to gradual
 real appreciation over the foreseeable future.

 1. Using 12-month rolling standard deviations,
    the average real trade weighted developing
    country exchange rate had a lower volatility
    than the same measure for the US dollar 68.8
    percent of the time.

 De Mello, L., P.C. Padoan, and L. Rousová
  (2011). ―The Growth Effects of Current
  Account Reversals: The Role of
  Macroeconomic Policies.‖ OECD Working
  Paper 871, OECD: Paris

 G20 2011. ―G20 Coherent Conclusions for the
  Management of Capital Flows Drawing on
  Country Experiences.‖   Adopted at G20
  Summit, Cannes, November 3-4, 2011.

 Ricci, L.A., G.M. Milesi-Ferretti, and J. Lee.
  2008. ―Real Exchange Rates and
  Fundamentals: A Cross-Country Perspective.‖
  IMF Working Paper 08/13, International
  Monetary Fund: Washington DC.

 Qureshi, M. S., J. D. Ostry, A. R. Ghosh and M.
  Chamon. 2011. ―Managing capital inflows:
  The role of capital controls and prudential


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