Portfolio Composition and Valuation Effects in Emerging Market Economies*

ABSTRACT

The increase in cross-border assets and liabilities of nations with globalization, implies small asset price and currency movements create large wealth changes. The national net external position is increasingly driven by valuation effects, which the current account does not capture. We analyze valuation effects for a group of seven emerging economies, namely Brazil, Colombia, India, Republic of Korea, Mexico, Peru and Turkey for the time period 2005:Q1-2015:Q4 by scrutinizing their external asset portfolio while controlling for country fundamentals. Both asset and liability categories of Direct Investment equity are found to positively impact valuation. Equity liabilities and debt assets of Portfolio Investment positively influence valuation. Debt liabilities of all kinds of investment negatively impact valuation. Countries with stronger currency tend to gain through valuation effects. An appreciated real effective exchange rate is associated with higher valuation gains. We also found non-linear effects of the composition of external debt portfolio by interacting external portfolio and country characteristics. The external portfolio selection of emerging economies (with more in Direct Investment equity liabilities and Portfolio Investment debt assets) in the period has shielded them from global volatility, and enabled valuation gains.     

Relative productivity increases and the appreciation of the Turkish lira

This paper studies the Balassa–Samuelson hypothesis between Turkey and 27 members of the European Union. More specifically, using recently developed cointegration techniques with multiple breaks, we test the relationship between the real effective exchange rate and inter-country differences in the relative productivity of the tradable and non-tradable sectors over the period 1990:Q1–2011:Q2. In recent years, the Central Bank of the Republic of Turkey (CBRT) has emphasized the importance of the B–S hypothesis for Turkey. Our findings, however, suggest that changes in relative productivity have played a limited role in explaining the real effective exchange rate appreciation. In particular, the relationship between the real effective exchange rate and productivity indicated by the Balassa–Samuelson hypothesis is not supported for the post 2001 era in Turkey.     

International Reserves and the Composition of Foreign Equity Investment

This paper studies the effect of central banks' international reserve hoardings on the composition of foreign equity investment. Specifically, it examines whether reserves affect the share of foreign portfolio equity investment (PEI) in total foreign equity investment, which includes both PEI and foreign direct investment (FDI). Foreign investors' decisions regarding the location and the type of equity capital investment might be influenced by a country's level of international reserves. In a simple theoretical model, it is shown that higher reserves, thanks to their ability to lower exchange rate risk, reduce the risk premium of PEI. Hence, higher reserves are expected to increase the inflow of PEI relative to FDI. This hypothesis is tested for a sample of 76 developing countries during the period 1980–2010 using different estimation methods, model specifications and data samples. The results suggest that higher levels of reserves are associated with a larger share of PEI relative to FDI. This result points to a collateral benefit of reserves that has been neglected so far. Reserves may contribute to develop domestic financial markets and facilitate domestic firms' access to foreign portfolio equity financing. In addition, this paper finds a strong negative effect of the global financial crisis beginning in 2008 on the share of PEI, which confirms the hypothesis that PEI is more crisis‐dependent than FDI.     

外汇储备与金融危机中的汇率稳定

本文首先分析了2008年全球金融危机下的外汇储备与实际有效汇率,结果表明2007年外汇储备存量更高和2008年外汇储备流量增加更多的国家,在2008年发生全球金融危机时保持了更稳定的汇率.在进一步对外汇储备与实际有效汇率的关系做了面板数据分析后,得出以下结论:外汇储备可以降低实际有效汇率的波动率,但这种效应是非线性的;更高的外汇储备充足率代表在危机状况下实行外汇市场干预的更大潜力;其他经济变量如一国的经济增长速度提高、货币供应量的波动降低、贸易条件的改善以及国内金融深化程度的加强都能降低有效汇率的波动.     

Estimating an equilibrium exchange rate for the dollar and other key currencies

In this paper, we adapt the concept of fundamental equilibrium exchange rates ‘FEER’ in a complete model approach. We use it to determine the likely paths of the Dollar and other key currencies. The FEER is the (real) exchange rate that is consistent with internal balance and sustainable external balances. Here we examine the composition of a Dollar adjustment and hence the extent to which a FEER (for the US) depends on factors or rigidities elsewhere in the world, as well as at home. We find, the US still needs to accept an adjustment in her real exchange rate if the increase in her foreign liabilities is to come to an end. However, counterpart adjustments also have to be made in Canada, Mexico, and some Asian economies if this policy is to be successful. We also show that productivity growth differentials may act as a substitute for depreciation, and this provides an explanation for the failure of the dollar to depreciate in the 1990s.     

Limited asset market participation and the consumption‐real exchange rate anomaly

Abstract Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country's aggregate consumption rises relative to foreign consumption, when the country's real exchange rate depreciates. Yet empirically, relative consumption and the real exchange rate are essentially uncorrelated. This paper shows that this ‘consumption‐real exchange rate anomaly’ can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand‐to‐mouth (HTM) lives. HTM behaviour also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.     

The Effect of Changes in Real Exchange Rates on Employment: Evidence from Manufacturing Industries in China, 1980–2002

This paper analyzes the effect of changes in real exchange rate on manufacturing employment. Our theoretical model predicts the positive effect of depreciation of real exchange rate on employment through a firm’s expectation on changes in real exchange rate and the interaction between real exchange rate and a firm’s import and domestic input. Using China’s manufacturing data during the 1980–2003 period, we find that depreciation of real exchange rate promotes employment growth in manufacturing industries, while change in real exchange rate is not a significant factor in promoting wage growth. We also find that an increase in export share offsets partially the effects of real exchange rate on employment and real wages. Translated from Journal of World Economy, 2005, (4): (in Chinese)     

The changing nature of the real exchange rate: The role of central bank preferences

We investigate the sources of real exchange rate fluctuations. We do so, first, in the context of a DSGE model that explicitly considers the central bank's preferences. Then we estimate SVAR models, where shocks are identified by sign restrictions derived from the DSGE model. We perform this exercise for twelve countries, nine of which have adopted inflation targeting during the period analyzed. In sharp contrast to the previous evidence in the literature, we find that exchange rate (country risk premium) shocks have become the main drivers of real exchange rate dynamics, while real shocks play a less important role. Evidence from the DSGE model reveals that, as the central bank becomes more averse to inflation movements, and cares less about nominal exchange rate fluctuations, the impact of nominal shocks on the real exchange rate tends to increase, while the impact of real shocks decreases. Our results suggest that the adoption of inflation targeting, along with a floating exchange rate, contributes to a shift in the relative importance of demand and country risk premium shocks in determining the RER.     

Hoarding for stormy days—Test of international reserves adjustment providing financial buffer stock services

This paper outlines a tractable cost‐benefit analysis of the buffer stock financial services provided by international reserves (IR) and applies it to eight of the largest Emerging Markets (BRICS, Indonesia, Mexico, Turkey) during 2000–2019. The efficient management of IR generates sizable benefits for countries characterized by hard‐currency external debt. These benefits increase with the volatility of the real exchange rates and sovereign spreads. While the first‐best policy calls for prudential regulations, counter‐cyclical management of hoarding reserves in good times and selling them in bad times provides buffers stock financial services adding up to about 3% of the gross domestic product during our sample period.     

Denomination composition of trade and trade balance: evidence from Turkey

The currency denominations of a country's exports and imports are not necessarily the same. If this is the case, then a change in the exchange rate parity among major currencies will affect the trade balance. The empirical evidence provided from Turkey – where exports are mostly denominated in Euros and imports are mostly denominated in USD – suggests that an appreciation of the Euro against the USD would increase the output in the long-run, appreciate the local currency and improve the trade balance for the 1985:01 2003:07 period.     

The effects of government spending shocks on the real exchange rate and trade balance in Turkey

The aim of this study is to investigate the effects of government spending shocks on the real exchange rate and foreign trade balance in Turkey for the period of 2002:01–2012:04 within a structural VAR framework. The analysis shows that a positive shock to the government spending tends to induce real exchange rate appreciation and deterioration in trade balance. We also find that the composition of the government spending matters. Although shocks to the government nonwage consumption generate an appreciation in the real exchange rate and worsening of the trade balance, the effects of government investment shocks remain insignificant. Furthermore, the analysis demonstrates that shocks to government spending are associated with a rise in taxes, which is indicative of a spending-driven tax adjustment process in Turkey.     

我国外汇储备经营收益的实证研究

近年来我国外汇储备大幅增长,其经营收益自然也备受关注。本文利用公开的全国银行结售汇月度时间序列数据,运用计量经济学方法对2000年-2004年期间银行结售汇在外汇储备增长中的作用进行了实证研究,并间接地对外汇储备经营情况进行了估计,结果表明：第一,结售汇顺差不断扩大决定了近年来外汇储备不断增长的长期趋势,结售汇顺差额约占新增外汇储备的80％;第二,外汇储备经营收益约占新增外汇储备的20％,是我国外汇储备增长不可忽视的重要原因。由此也揭示了外汇储备的经营损益对外汇规模的影响已难以忽视,政府应增加外汇储备经营状况的透明度,以利于更好地形成合理的人民币汇率预期。     

Exchange Rate Dynamics with Foreign Reserves: Revisiting the Dornbusch Overshooting Model

The purpose of this study is to shed light on the management of foreign reserves that possibly have contradictory policy intentions and impacts, for instance, (1) to defend the domestic currency, (2) to depreciate the domestic currency. With this Möbius's strip‐like nature in mind, we extend the Dornbusch (1976) exchange rate overshooting model with the foreign reserves. Depending on financial vulnerability, the presence of foreign reserves could amplify or alleviate monetary policy shocks on the exchange rate.     

The 2014–15 Financial Crisis in Russia and the Foundations of Weak Monetary Power Autonomy in the International Political Economy

ABSTRACT

This article contributes to international political economy debates about the monetary power autonomy (MPA) of emerging market and developing countries (EMDs). The 2014–15 Russian financial crisis is used as a case study to explore why an accumulation of large international reserves does not provide protection against currency crises and macroeconomic adjustments in EMDs. The analysis centres on the interplay between two dimensions of MPA: the Power to Delay and the Power to Deflect adjustment costs. Two structural factors condition Russia’s low MPA. First, the country’s subordinated integration in global financial markets increases its financial vulnerability. The composition of external assets and liabilities, combined with cross-border capital flows, restrict the use of international reserves to delay currency crises. Second, the choice of a particular macroeconomic policy regime embraced the financialisation of the – mainly state-owned – Russian banking sector, thus making it difficult to transform liquidity inflows into credits for enterprises. Russia’s main comparative advantage, hydrocarbon export revenues, is not exploited. The type of economy created due to the post-Communist transition means that provided ‘excessive’ liquidity remains in the financial system and is channelled into currency arbitrage. This factor increases exchange rate vulnerability and undermines Russia’s MPA.     

Estimating the import demand function for China

This paper estimates the import demand elasticity for China using three fully efficient cointegrating regressions and the autoregressive distributed lag (ARDL) method. This paper is the first to accommodate the perception of global risk in an investigation of the information transmission mechanism between the relationship import demand and its determinants in China. The empirical results show that real imports are cointegrated with domestic economic activity, real effective exchange rate, and the perception of global risk. Domestic income is found to have a significantly positive effect on imports. Contrary to theory, the real effective exchange rate carries negative coefficients, which suggests that a decrease in external competitiveness (appreciation) will decrease the level of imports in the case of China. One of the reasons for this may be the tied anti-dumping duty on some import items. Since the perception of global risk adversely affects China's aggregated imports, policy-makers should consider the degree to which the perception of global risk affects the implementation of trade policies.     

Exchange rate volatility and export growth in Nigeria

This article examines the impact of exchange rate volatility on Nigeria's exports to its most important trading-partner–the United States over the quarterly period January 1980 to April 2001. Using cointegration and vector error correction (VECM) framework, empirical tests indicate the presence of a unique cointegrating vector linking real exports, real foreign income, relative export prices and real exchange rate volatility in the long run. Furthermore, the results show that increases in the volatility of the real exchange rate raise uncertainty about profits to be made which exert significant negative effects on exports both in the short- and long-run. Our results also show that improvements in the terms of trade (represented by declines in the real exchange rate) and real foreign income exert positive effects on export activity. Most importantly, we found that the trade liberalization and economic reform policies implemented in the post-1986 structural adjustment period contributed to Nigeria's export performance. Overall, our findings suggest that Nigeria's exporting activities can be further boosted by policies aimed at achieving and maintaining a stable competitive real exchange rate.     

The effect of natural gas discoveries in Israel on the strength of its currency

In light of the natural gas discoveries in the Mediterranean Sea and their impact on the Israeli economy, I must assess the change in the exchange rate and its impact on the foreign exchange market. There are numerous positive social impacts resulting from the gas discoveries including optimising Israel's energy security and its move to cleaner energy. However, not all of the consequences of discovering natural resources may be positive. One possibly negative outcome could be the well-known phenomenon called the “Dutch disease” in which the discovery of a natural resource can cause a country's currency to spike. To investigate whether the strengthening of the Israeli currency in recent years is a symptom of the “Dutch disease” I used daily and intraday event study methodology to explore the changes in the real exchange rate of the Israeli shekel and the US dollar between 2008 and 2017, according to announcements related to the gas discoveries published during this period. In addition, I examined whether an increase in the real exchange rate was a result of the publication of announcements about natural gas harming the manufacturing and industrial sectors. I found that announcements related to gas discoveries did affect the real exchange rate and caused an appreciation of the Israeli shekel. Investors could analyse the announcements and achieve an abnormal return in the foreign exchange market. In addition, investors' expectations of an appreciation in the real exchange rate causes damage to various manufacturing and industrial sectors.     

The impact of setting negative policy rates on banking flows and exchange rates

In the aftermath of the great contraction of 2008, policymakers were faced with the Zero Lower Bound (ZLB) on nominal interest rates. Central banks implemented several unconventional monetary policies to overcome the ZLB, including setting negative nominal interest rates. This paper explores possible unintended effects of setting negative policy rates. Using Danish data, I assess the impact of paying a negative interest rate on reserves. Results suggest that going into negative territory has a particular impact, distinct from that of simply lowering interest rates: it leads to higher banking outflows and depreciation of the currency. Due to the reluctance of commercial banks to pass on negative rates to their depositors (retail deposits can easily be switched into cash), paying a negative (vs. positive) interest rate on reserves creates a disconnection between the assets and liabilities of commercial banks' balance sheets. Commercial banks can avoid this disconnection by holding external assets or assets in foreign currencies. This incentive to increase banking outflows appears to explain the particular impact of going into negative territory.     

(Asymmetric) trade costs,real exchange rate hedging,and equity home bias in a multicountry model

There has been controversy between (two‐country) theory and the empirics about whether hedging against real exchange rate fluctuations in the goods market influences foreign equity holdings. This study reconciles the theory with the empirics by introducing a multicountry framework with asymmetric trade costs. We find that the incentive to hold foreign equities to hedge real exchange rate risk is negligible because multiple trade partners act as a hedging channel for real exchange rate fluctuations. Further, our theory calls for a country's covariance–variance ratio to be constructed as the sum of the bilateral covariance–variance ratios of the multiple partners. The empirical analysis of 24 advanced countries confirms the theoretical prediction.     

The European Single Currency and MENA's Exports to Europe

The paper investigates future exchange rate policy of the Middle East and North African (MENA) countries vis‐à‐vis the euro aimed at fostering their manufactured exports towards Euroland. The exchange rate policy is captured through three different indicators: the real effective exchange rate changes, volatility, and misalignment. The investigation is conducted for 11 sectors over the period 1970–1997. The sample includes four North African countries (Algeria, Morocco, Tunisia, Egypt) and Turkey. The results show that exchange rate management plays a crucial role in providing incentives for manufactured exports toward Euroland. The food sector is weakly responsive to real exchange rate changes while the textile sector is highly responsive. Four growing sectors (electronic, electrical, mechanical, and vehicles) were also found to be highly sensitive to exchange rate changes. The results suggest that policymakers should be more concerned with misalignment than with volatility.