• Share
  • Email
  • Embed
  • Like
  • Save
  • Private Content
Currency Crisis
 

Currency Crisis

on

  • 948 views

 

Statistics

Views

Total Views
948
Views on SlideShare
933
Embed Views
15

Actions

Likes
0
Downloads
0
Comments
0

3 Embeds 15

http://szahmed.com 13
http://www.slideshare.net 1
https://www.linkedin.com 1

Accessibility

Categories

Upload Details

Uploaded via as Microsoft PowerPoint

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment
  • In the long run, a currencies value mirrors the fundamental strength of the underlying economy. In the short run, investor sentiment plays an important role. “ Fight or flight” mentality Currency crises becoming self-fulfilling prophecies
  • First Generation Models (Krugman, 1979) Focus on macroeconomic fundamentals and fiscal/monetary policy Excessive expansionary monetary and/or fiscal policy eventually leads to a recurrent loss of international reserves that ultimately makes crisis unavoidable. Political/legal instabilities act to augment risk. Second Generation Models (1992) Focus on the relationship between investor expectations and actual results from policymaking. “ A currency crisis can be thought of as a shift in expectations toward the devaluation outcome. Such a shift suddenly makes the defense of the exchange rate peg excessively costly.” – Paolo Pesenti and Cedric Tille Investor sentiment of long-term macroeconomic movements plays a large role in future currency crises Third Generation Models (1992) Point to the role of contagion “ In the absence of common shocks, a currency crisis can be transmitted from one country (A) to another (B) if structural links and international spillovers make the economies of countries A and B interdependent. That is, if the currency devaluation by country A has a negative impact on country B’s fundamentals, it will eventually force country B’s currency devaluation.” – Pesenti and Tille Links in trade and finance Economies of developing countries with liberal laws regarding capital flows are more susceptible to crisis than those nations with strict controls on foreign investment/repatriation.
  • Capital Account Explained Includes all purchases and sales of assets, such as stocks, bonds, banks accounts, real estate, and businesses.” – Eun and Resnick. In aggregate, represents the difference between the sale of US assets to foreign nations and the purchase of foreign assets by the U.S. Variables that may act as leading indicators from the Capital Account include: reserves, real interest rate differential, foreign debt/exports, capital flight.
  • Exchange rate depreciation - At the beginning of the year, the spot rate was about 15,800 dong per U.S. dollar. During the middle of the summary, the rate moved to about 16,800 dong per U.S. Dollar. Much of this is due to the widening the band at which the dong may fluctuate from the dollar.
  • Argentina is likely to undergo another currency crisis because of High inflation rate (official 8% vs actual 25%) 40% debt in form of government issued inflation linked bond yielding 8.9%  domestic default Irresponsible fiscal and monetary policies Introduced export taxes, upset farmers (mainly commodities such as soybean, corn. Pension funds became public to pay off foreign debt. Low interest rate resulting in inflation (failed to raise it during good times) Overvalued exchange rate 1$ (US) : 3.30 (Arg peso) (‘defending at all cost’ approach by depleting reserves, won’t be able to sustain for long) Current account reduction In 2007, it was $2.812 (%change: -48.05) In 2008, it is $1.816 (% change: -57.82) Decrease in GDP growth In 2008, it reduced by 19.74%. No trust on government Argentineans have low level of confidence because of past experiences, withdrawing money in large amounts which may lead to run on banks. Investors and creditors especially foreigners are afraid because of previous default. Declining commodity prices Exporter of soybean, corn, would see drastic reduction in balance of payment account. Hugo Chavez won’t come to rescue, decreasing oil prices and other internal political problems.
  • Argentina is likely to undergo another currency crisis because of High inflation rate (official 8% vs actual 25%) 40% debt in form of government issued inflation linked bond yielding 8.9%  domestic default Irresponsible fiscal and monetary policies Introduced export taxes, upset farmers (mainly commodities such as soybean, corn. Pension funds became public to pay off foreign debt. Low interest rate resulting in inflation (failed to raise it during good times) Overvalued exchange rate 1$ (US) : 3.30 (Arg peso) (‘defending at all cost’ approach by depleting reserves, won’t be able to sustain for long) Current account reduction In 2007, it was $2.812 (%change: -48.05) In 2008, it is $1.816 (% change: -57.82) Decrease in GDP growth In 2008, it reduced by 19.74%. No trust on government Argentineans have low level of confidence because of past experiences, withdrawing money in large amounts which may lead to run on banks. Investors and creditors especially foreigners are afraid because of previous default. Declining commodity prices Exporter of soybean, corn, would see drastic reduction in balance of payment account. Hugo Chavez won’t come to rescue, decreasing oil prices and other internal political problems.

Currency Crisis Currency Crisis Presentation Transcript

  • Leading Indicators of a Currency Crisis: From Fundamentals to Contagion Edward Mongon, Syed Zillur Rehman, and Divya Yerraguntla International Capital Markets 11/25/08
  • Agenda
    • Introduction
      • Currency Crisis Defined
    • Related Literature
      • Three main models of Currency Crises
    • Set of Leading Indicators
      • Deterioration of the Capital Account
      • Weakening Current Account
      • Growth Slowdown
    • Forecasting Future Crises
      • Vietnam
      • Argentina
      • Ukraine
  • Summary
    • This presentation has two main goals:
      • Determine what drives currency crises.
        • Develop a set of leading indicators that enable a sovereign nation – either industrial or developing, to understand whether or not they may be vulnerable to a currency crisis in the near future.
      • Forecast three major countries that are likely headed towards crisis.
  • Currency Crisis
    • Definition: A situation in which an attack on the currency leads to substantial reserve losses, or to a sharp depreciation of the currency – if the speculative attack is ultimately successful – or to both.
    • In the long run, a currencies value mirrors the fundamental strength of the underlying economy.
    • In the short run, investor sentiment plays an important role.
      • “ Fight or flight” mentality
      • Currency crises becoming self-fulfilling prophecies
  • Currency Crisis Continued
    • As long as international markets remain stable, investors may be willing to finance the economic growth of developing nations.
      • When fundamental conditions worsen  flight of short-term portfolio capital likely to ensue.
    • The result of such a situation can be can be devastating:
      • Decline in foreign credit
      • Contraction in output
      • Increase in unemployment
      • Even collapse of banks
      • Credit crunch spillover to nearby nations
  • Related Literature
    • First Generation Models (Krugman, 1979)
      • Macroeconomic fundamentals and fiscal/monetary policy
      • Recurrent loss of international reserves
      • Political/legal instabilities act to augment risk.
    • Second Generation Models (1992)
      • Relationship between expectations and actual results
      • Shift in expectations toward the devaluation outcome
      • Long-term macroeconomic movements
    • Third Generation Models (1992)
      • Point to the role of contagion
      • Links in trade and finance
  • Leading Indicators – Capital Account
    • Level of International Reserves
      • Most predictable indicator of a currency crisis over time.
      • As seen with many countries trying to maintain exchange rate parity, the persistent loss of reserves in the attempt to maintain such parity eventually causes policy makers to abandon the peg and allow the currency to float
    • Real Interest Rate Differential
      • Ceteris Paribus, a rise in the level of interest rates in one nation will cause investors to flock to that nation in order to take advantage of the higher rates of return.
      • The capital inflow will help foreign investors diversify their holdings.
      • However, it interest rate differentials that lead to a capital outflow weakens a country’s balance of payments and require a net payment to be made to foreign nations.
      • This causes a rundown in official reserve assets.
  • Capital Account Continued
    • Foreign Debt / GDP
      • The more foreign debt that is needed to produce promote economic growth within a country, the more vulnerable that country is to adverse financial shocks.
      • Increase in ratio results in reduced capital mobility.
      • Also, higher debt level leads to a currency devaluation.
    • Capital Flight
      • Nations with liberalized capital controls are more apt to the flight of short-term portfolio capital.
      • When tight restrictions are placed, currency runs are less likely to occur.
        • ex) China and India
  • Leading Indicators – Current Account
    • Current Account Balance
      • Deteriorating current account balance indicates possible currency crises.
      • Determinants of current account are exports, imports, real exchange rate, terms of trade.
      • Current account surplus if
        • Export > Imports
        • Exports
          • Exports goods based on comparative advantage.
      • Current account deficit exists if
        • Imports > Export
        • Import growth can be attributed to currency crisis, although weak indicator.
  • Current Account (Contd..)
    • Real Exchange Rate
      • Fixed
        • Overvalued (Argentina) – protect capital outflow, loss of reserves to maintain parity, matter of pride.
        • Devaluation
        • Undervalued (China) – exports remain cheap relatively
      • Free Floating (Australia, US, Eurozone)
        • Endogenously adjusted
      • Managed floating (India, Nigeria, Thailand)
        • Between fixed and floating, some flexibility
  • Leading Indicators – Growth Slowdown
    • Growth Slowdown
      • Growth Slowdown Explained
        • Output
        • Domestic real interest rate
        • Lending/Deposit Rate Ratio
        • Stock Prices
      • Three Observations for Growth Slowdown
        • Purchasing power parity calculations, which suggested that costs and prices have gotten out of line with those of trading partners;
        • Large current account deficits;
        • Slow growth (in the case of Mexico) or high unemployment (in the case of Argentina), suggesting that there would be room for monetary expansion if only the exchange rate were not a constraint.
  • Growth Slowdown Continued
    • Slowdown Theories
      • Sudden shifts in market expectations and confidence
      • Sources of the initial Financial turmoil, its propagation over time and regional contagion.
      • Structural and policy distortions in the countries of the region
    • Cause/Effect
      • Slow down in demand results in slow down in productivity.
      • Over heated reaction to slowdown results in drop in exchange rates.
      • Productivity changes affect real rates of return and price/earnings ratios.
  • Forecasting Future Crises
    • Vietnam
      • Four main problems – overheated economy, surging inflation, widening trade imbalance, excessive credit growth
    • Overheated Economy, Excessive credit growth
      • 2005-2007 – market capitalization of Vietnamese countries rose from $1 billion to $29 billion.
      • As well, FDI inflows were up to $6.7 billion.
      • Credit Growth by the government exceeded 30 percent in successive years.
      • The country was to pay for such large growth in such a short time.
  • Vietnam Continued
    • Inflation, Trade Imbalances
      • Currently, the level of inflation is at 25%, and is expected to rise further.
      • As a result, the real exchange rate has gone up dramatically; this has caused large balance of payments issues.
      • The nations trade deficit was $14.4 billion as of May 2008. This figure has $12.4 billion for all of 2007.
    • How have Vietnamese citizens coped?
      • By hording physical assets like gold and silver.
    • Exchange Rate depreciation
    • How is the government dealing with this problem?
      • They plan on using whatever international reserves are available in order to stabilize the value of the dong. This is the wrong move.
      • The government will likely run out of their $22-$24 billion in reserves very quickly.
  • Argentina - Currency crisis
    • Argentina is likely to undergo another currency crisis because of
      • High inflation rate (official 8% vs actual 25%)
      • Irresponsible fiscal and monetary policies
      • Overvalued exchange rate
      • 1$ (US) : 3.30 (Arg peso) (‘defending at all cost’ approach by depleting reserves, won’t be able to sustain for long)
      • Current account reduction
        • In 2007, it was $2.812 (%change: -48.05)
        • In 2008, it is $1.816 (% change: -57.82)
      • Decrease in GDP growth
        • In 2008, it reduced by 19.74%.
      • No trust on government
      • Declining commodity prices
  • Ukraine - Currency crisis
    • Ukraine is likely to undergo a currency crisis because of
      • High inflation rate (16.6% in 2007)
      • Lax monetary policy
      • Overvalued exchange rate
      • Collapse of the governing coalition
    • Foreign-currency reserves shrank 15 percent to $31.9 billion in October 2008
    • Nominal GDP growth
      • $147.4bn in the first nine months in 2008
      • $17.9bn in September 2008
    U.S. Dollar to Ukraine Hryvnia
  • Any Questions