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2005:Exchange Rates and Devaluation

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2005:Exchange Rates and Devaluation

1. 1. Exchange Rates and Devaluation Presentation to RICS Botswana Keith Jefferis November 30, 2005 Structure• The mechanics of exchange rates• Exchange rates & competitiveness• Why devalue?• Impact of devaluation2 2 1
2. 2. Exchange Rates• Value of Pula determined in relation to basket of currencies (ZAR, SDR) with fixed weights.• Weights reflect trade patterns, changed rarely, kept secret• Exchange rate of pula vs. the basket can be changed (=re/devaluation, crawling peg)3 3 Exchange Rates• Nominal Effective Exchange Rate (NEER) α β  BWP   BWP    .  =K  ZAR   SDR • weighted average of bilateral exchange rates• Bilateral exchange rates (e.g. pula-rand) move on cross-rates (e.g. rand-dollar)• Bilateral rate movements (BWP/ZAR, BWP/SDR) in opposite directions and cancel each other out – hence NEER constant - unless re/devaluation4 4 2
3. 3. 140 130Index 1996=100 120 110 100 90 NEER BWP/ZAR 80 BWP/USD 70 60 50 2002 2003 2004 20055 5 Competitiveness• Real Exchange Rate – Relative domestic and foreign prices adjusted for nominal exchange rate  Pd  REER =  f   P . XR    – Competitiveness declines (REER rises) if: • domestic prices rise faster than foreign prices • exchange rate appreciates – Botswana’s problem is the former6 6 3
4. 4. Real & Nominal Effective Exchange Rates 1995-2005 125 120 115 110 105 100 95 90 85 NEER REER 80 95 96 97 98 99 00 01 02 03 04 05 19 19 19 19 19 20 20 20 20 20 207 7 Inflation – Botswana and Trading Partners 20% 15% 10% 5% 0% -5% 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 Inflation Trading Partner Inflation (avg.)8 8 4
5. 5. Competitiveness• Botswana prices high relative to trading partners/competitors• Relative prices determined by costs of what is produced in Botswana (value added)• Botswana net costs (= incomes) high relative to value of what we produce• Costs have to be reduced either by reducing incomes or increasing productivity9 9 Sectoral effects• Tradeables (exports or import substitutes) – includes, goods, some services – prices determined internationally – low profits/returns – investment discouraged• Non-tradeables – most services, property – prices determined locally (high) – high profits/returns – (over) investment encouraged• Wrong incentives!10 10 5
6. 6. Why Devalue?• Economic growth in Botswana MUST be export-led (small domestic market)• International/historical evidence very clear – e.g. China, E. Asia vs. Latin America• Must be competitive to export• Exchange rate a crucial determinant of competitiveness (along with domestic costs)11 11 Impact of Devaluation• Doesn’t higher inflation erode the initial impact on competitiveness? – only partially – impact on inflation always less than 100% – e.g. 2004 devaluation of 7.5% added 2%-4% to inflation – 2005 devaluation of 12% added 4%-5% to inflation – some competitiveness gains remain12 12 6
7. 7. Impact of Devaluation• Initial (short-term): – Higher import costs (-) – Higher inflation (but small effect) (-) – Reduced real wages and incomes (-) – Profit squeeze in import-intensive sectors (-) – Profitability of tradeables sectors improves vis a vis non-tradeables (+) – Improved international competitiveness (+) – Higher government revenues (+)13 13 Impact of Devaluation• Medium term – Support for exports and diversification – Support for higher economic growth, but – Devaluation a necessary but not a sufficient condition for higher growth – Need to deal with underlying cost factors – Crawling peg should eliminate need for further devaluations – Choices: compete or stagnate14 14 7
8. 8. Impact on Property Sector• Relative to some other sectors, property likely to be disadvantaged, especially in short run – devaluation aims to enhance exports & import- competing sectors vs. non-tradeables – recent over-investment in property – now, higher costs, reduced profits• Medium-long term: higher economic growth will support all sectors, including property15 15“There is a strong association between[growth] acceleration episodes and trade.Episodes are correlated with strong growthin the economies of a country’s tradingpartners, export growth, and a competitivereal exchange rate. Exports were alsofacilitated by REER depreciations …. pointingto the importance of careful management ofcompetitiveness regardless of the exchangerate regime” (IMF, 2005, Sustaining GrowthAccelerations and Pro-poor Growth in Africa) Pro-16 16 8