## 7. Fear-of-Floating Effects

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### Introduction
- Purpose: Proposes a broad set of quantitative indicators (a “template”) to assess exchange rate regime choice based on analytical factors identified in the literature.
- Sample: 51 economies.
- Key factors selected: trade orientation; financial integration; economic diversification; macroeconomic stabilization; credibility; and “fear-of-floating” type effects.
- Ranking rule: a country ranks among the top 10 percent (next 20 percent) of the distribution if it is a “high” (relatively high) candidate for a fixed regime on a particular criterion.
- Application: Template illustrated for Kazakhstan and Pakistan.

### De facto regimes in Kazakhstan and Pakistan
- De facto peg definition (Reinhart and Rogoff, 2004): exchange rate fluctuates by one percent or less at least 80 percent of the time (using 5-year and 2-year windows).
- Pakistan: de facto peg to the dollar for much of the period since early 1990s (despite occasional large parity adjustments).
- Kazakhstan: downward pressure in the 1990s; de facto peg emerged early this decade against both the U.S. dollar and the ruble (2001–2002); 2003–2004 appreciation increased flexibility beyond the de facto peg threshold.

### Template — Analytical considerations and empirical measures
- Overall assessment approach: cross-country comparisons and percentile-based inference where low ranking can imply a case for a peg and high ranking a case against a peg.

A. Economic integration / Optimal currency areas
- Measures:
  - Trade orientation: exports plus imports to GDP.
  - Trade pattern concentration: weight of top currency in total exports.
  - Cyclical synchronicity: correlation of annual GDP growth with main trading partner.
- Key country indicators:
  - Trade-to-GDP: Pakistan (29); Kazakhstan (66.3).
  - Share of exports to main partner currency area: Pakistan (32.7); Kazakhstan (45.2).
  - Real GDP growth correlation with key export partner: Pakistan (-0.11); Kazakhstan (0.83).
- Conclusions:
  - Pakistan: trade orientation among the lowest in the sample → case against a peg.
  - Kazakhstan: middle-ranked trade orientation; strong cyclical synchronicity with Russia → potential advantage to a stable tenge-ruble rate (but see later caveats).

B. Financial integration
- Measures:
  - Inclusion in major indices (MSCI, EMBI+, IFC indices).
  - Stock market capitalization/turnover to GDP.
  - Financial development: broad money-to-GDP ratio.
- Key country indicators:
  - Stock market turnover (% of GDP, 2003): Pakistan (7.1); Kazakhstan (2.0).
  - Broad money to GDP ratio (1992-2002): Pakistan (45.8); Kazakhstan (13.75).
- Conclusions:
  - Pakistan: inclusion in most emerging market indices and relatively developed capital market turnover → case against a peg.
  - Kazakhstan: historically not in major indices and low monetization → modest case for a peg historically (but see recent changes).

C. Diversification / Terms of trade
- Measures:
  - Terms of trade volatility (coefficient of variation; 1985-2003).
  - Share of primary commodities in exports / GDP (1990-99).
  - Correlation of world commodity prices (lagged) with domestic GDP growth.
- Key country indicators:
  - Terms of trade volatility: Pakistan (0.08); Kazakhstan (0.15).
  - Primary commodities exports ratio to GDP: Pakistan (0.02); Kazakhstan (0.25).
  - Correlation commodity prices and activity (lagged): Kazakhstan (0.25); Pakistan (contemporaneous; 0.28).
- Conclusions:
  - Pakistan: mixed—low terms of trade volatility and low primary-commodity share, but high correlation with cotton prices (indicating dependence) → moderate case against a peg.
  - Kazakhstan: high share of primary commodity exports and high correlation with commodity prices → substantive case against a peg.

D. Stabilization (Mundell-Fleming framework)
- Measures:
  - Capital mobility proxy: ratio of cumulative gross capital flows to trade flows (1995-2003).
  - Monetary shocks: coefficient of variation of broad money to GDP ratio (1993-2002).
  - Real versus nominal shocks: ratio of COV of monetization to COV of terms of trade.
- Key country indicators:
  - Capital versus trade flows: Pakistan (0.15); Kazakhstan (0.29).
  - Monetary shocks (COV of broad money/GDP): Pakistan (0.05); Kazakhstan (0.29).
  - Real v. monetary shocks (ratio): Pakistan (1.04); Kazakhstan (1.71).
- Conclusions:
  - Pakistan: real shocks more important than nominal shocks; peg would not be advantageous.
  - Kazakhstan: mixed/neutral historically but relatively high ratio of gross capital flows to trade flows (1995–2003) → disadvantage of a peg.

E. Credibility / Nominal anchor
- Measures:
  - Inflation history: proportion of months with year-on-year CPI inflation exceeding thresholds (10 percent and 8 percent) over 1994-2003 and 1999-2003 for sensitivity checks.
- Key country indicators:
  - Proportion of months inflation > 10% (1994-2003): Pakistan (0.34); Kazakhstan (0.56).
  - Proportion of months inflation > 8% (1994-2003): Pakistan (0.4); Kazakhstan (0.67).
- Conclusions:
  - Pakistan: middle of the sample → neutral case for/against peg on credibility grounds.
  - Kazakhstan: higher inflation history → potential sizable nominal anchor benefits from a peg (historically).

F. Fear-of-Floating / Balance-sheet effects
- Measures:
  - Reinhart-Rogoff-Savastano dollarization index (composite).
  - Correlation of exchange rate changes and subsequent economic activity (lagged).
  - Exchange rate pass-through: correlation of y-o-y CPI with lagged nominal effective exchange rate changes.
- Key country indicators:
  - Dollarization index: Pakistan (9); Kazakhstan (7).
  - Correlation real GDP and NEER (1993-2003): Pakistan (0.52); Kazakhstan (0).
  - Correlation NEER and CPI (1993-2003): Pakistan (-0.27); Kazakhstan (-0.64).
- Conclusions:
  - Pakistan: moderate degree of dollarization and little evidence of unusually high pass-through → modest case for a peg on fear-of-floating grounds (some evidence that depreciation is contractionary).
  - Kazakhstan: relatively low historical dollarization and limited evidence of balance-sheet effects historically → neutral case (but recent developments may change this).

### Scorecard (summary of findings for Pakistan and Kazakhstan)
- Aggregate assessment for Pakistan (based on historical data and template):
  - Fairly strong case against pegging the rupee.
  - Main reasons:
    - High integration with global financial markets → exposure to volatile private capital flows and risks under a peg.
    - High dependence on cotton → need for exchange rate adjustment to commodity price shocks.
    - Real shocks dominate nominal shocks → peg not advantageous for stabilization.
    - Low external trade orientation → limited trade gains from a peg.
    - Caveat: some evidence that rupee depreciation can be contractionary (fear-of-floating), but corporate dollar borrowing is limited, weakening balance-sheet arguments for a peg.
- Aggregate assessment for Kazakhstan (based on historical data and adjusted for recent changes):
  - Historical scorecard: mixed case for a peg.
  - Adjustments based on recent changes strengthen the case against a peg:
    - Rapid increase in external borrowing by private sector and rising monetization → greater international financial integration and vulnerability to capital flow volatility.
    - Sustained reduction of inflation to single digits → diminished nominal anchor benefits from a peg.
    - Continued commodity dependence and large real shocks → costs from foregoing exchange rate adjustment remain significant.
    - Dollarization rose after the Russian crisis and private external borrowing increased in 2004–05 → potential resurgence of fear-of-floating effects, which could strengthen arguments for a peg in the short term.
  - Net implication: moving toward greater exchange rate flexibility is advisable to contain financial risks and facilitate adjustment.

### Conclusions and policy implications
- The template provides an operational scorecard to assess whether a country’s de facto exchange rate regime is consistent with economic and financial considerations.
- Pakistan: evidence of “fear of floating” in practice, but the template indicates that a peg is not advantageous given Pakistan’s characteristics — increased exchange rate flexibility is likely to improve performance.
- Kazakhstan: transition-era instability limited pegging; as stability improved a de facto peg emerged, but more recent financial integration, lower inflation, and evolving trade patterns make a stronger case for increased flexibility going forward.
- General observation: trade-offs across considerations are common; country-specific prioritization of factors remains necessary.

*Source: Chapter 7, “Fear-of-Floating Effects,” IMF Working Paper _wp0654 (figures and tables as presented in the source).*

### References..............................................................................................................

### _wp0654 - References..............................................................................................................

### Tables
- 1. List of Countries in Sample .........................................................................................17
- 2.         Scoreboard ...................................................................................................................18

### Figures
- 1. Degree of Flexibility of Rupee and Tenge...................................................................19
- 2.         Trade         Orientation .........................................................................................................20
- 3.         Financial         Integration ....................................................................................................21
- 4.         Diversification..............................................................................................................22
- 5.         Stabilization .................................................................................................................23
- 6.         Credibility ....................................................................................................................24

*Source: _wp0654 - References..............................................................................................................*

### 7.         Fear-of-Floating         Effects.............................................................................

### 7. Fear-of-Floating Effects

### Introduction
- Purpose: Proposes a broad set of quantitative indicators (a “template”) to assess exchange rate regime choice based on analytical factors identified in the literature.
- Sample: 51 economies.
- Key factors selected: trade orientation; financial integration; economic diversification; macroeconomic stabilization; credibility; and “fear-of-floating” type effects.
- Ranking rule: a country ranks among the top 10 percent (next 20 percent) of the distribution if it is a “high” (relatively high) candidate for a fixed regime on a particular criterion.
- Application: Template illustrated for Kazakhstan and Pakistan.

### De facto regimes in Kazakhstan and Pakistan
- De facto peg definition (Reinhart and Rogoff, 2004): exchange rate fluctuates by one percent or less at least 80 percent of the time (using 5-year and 2-year windows).
- Pakistan: de facto peg to the dollar for much of the period since early 1990s (despite occasional large parity adjustments).
- Kazakhstan: downward pressure in the 1990s; de facto peg emerged early this decade against both the U.S. dollar and the ruble (2001–2002); 2003–2004 appreciation increased flexibility beyond the de facto peg threshold.

### Template — Analytical considerations and empirical measures
- Overall assessment approach: cross-country comparisons and percentile-based inference where low ranking can imply a case for a peg and high ranking a case against a peg.

A. Economic integration / Optimal currency areas
- Measures:
  - Trade orientation: exports plus imports to GDP.
  - Trade pattern concentration: weight of top currency in total exports.
  - Cyclical synchronicity: correlation of annual GDP growth with main trading partner.
- Key country indicators (as reported):
  - Trade-to-GDP: Pakistan (29); Kazakhstan (66.3).
  - Share of exports to main partner currency area: Pakistan (32.7); Kazakhstan (45.2).
  - Real GDP growth correlation with key export partner: Pakistan (-0.11); Kazakhstan (0.83).
- Conclusions:
  - Pakistan: trade orientation among the lowest in the sample → case against a peg.
  - Kazakhstan: middle-ranked trade orientation; strong cyclical synchronicity with Russia → potential advantage to a stable tenge-ruble rate (but see later caveats).

B. Financial integration
- Measures:
  - Inclusion in major indices (MSCI, EMBI+, IFC indices).
  - Stock market capitalization/turnover to GDP.
  - Financial development: broad money-to-GDP ratio.
- Key country indicators (as reported):
  - Stock market turnover (% of GDP, 2003): Pakistan (7.1); Kazakhstan (2.0).
  - Broad money to GDP ratio (1992-2002): Pakistan (45.8); Kazakhstan (13.75).
- Conclusions:
  - Pakistan: inclusion in most emerging market indices and relatively developed capital market turnover → case against a peg.
  - Kazakhstan: historically not in major indices and low monetization → modest case for a peg historically (but see recent changes).

C. Diversification / Terms of trade
- Measures:
  - Terms of trade volatility (coefficient of variation; 1985-2003).
  - Share of primary commodities in exports / GDP (1990-99).
  - Correlation of world commodity prices (lagged) with domestic GDP growth.
- Key country indicators (as reported):
  - Terms of trade volatility: Pakistan (0.08); Kazakhstan (0.15).
  - Primary commodities exports ratio to GDP: Pakistan (0.02); Kazakhstan (0.25).
  - Correlation commodity prices and activity (lagged): Kazakhstan (0.25); Pakistan (contemporaneous; 0.28).
- Conclusions:
  - Pakistan: mixed—low terms of trade volatility and low primary-commodity share, but high correlation with cotton prices (indicating dependence) → moderate case against a peg.
  - Kazakhstan: high share of primary commodity exports and high correlation with commodity prices → substantive case against a peg.

D. Stabilization (Mundell-Fleming framework)
- Measures:
  - Capital mobility proxy: ratio of cumulative gross capital flows to trade flows (1995-2003).
  - Monetary shocks: coefficient of variation of broad money to GDP ratio (1993-2002).
  - Real versus nominal shocks: ratio of COV of monetization to COV of terms of trade.
- Key country indicators (as reported):
  - Capital versus trade flows: Pakistan (0.15); Kazakhstan (0.29).
  - Monetary shocks (COV of broad money/GDP): Pakistan (0.05); Kazakhstan (0.29).
  - Real v. monetary shocks (ratio): Pakistan (1.04); Kazakhstan (1.71).
- Conclusions:
  - Pakistan: real shocks more important than nominal shocks; peg would not be advantageous.
  - Kazakhstan: mixed/neutral historically but relatively high ratio of gross capital flows to trade flows (1995–2003) → disadvantage of a peg.

E. Credibility / Nominal anchor
- Measures:
  - Inflation history: proportion of months with year-on-year CPI inflation exceeding thresholds (10 percent and 8 percent) over 1994-2003 and 1999-2003 for sensitivity checks.
- Key country indicators (as reported):
  - Proportion of months inflation > 10% (1994-2003): Pakistan (0.34); Kazakhstan (0.56).
  - Proportion of months inflation > 8% (1994-2003): Pakistan (0.4); Kazakhstan (0.67).
- Conclusions:
  - Pakistan: middle of the sample → neutral case for/against peg on credibility grounds.
  - Kazakhstan: higher inflation history → potential sizable nominal anchor benefits from a peg (historically).

F. Fear-of-Floating / Balance-sheet effects
- Measures:
  - Reinhart-Rogoff-Savastano dollarization index (composite).
  - Correlation of exchange rate changes and subsequent economic activity (lagged).
  - Exchange rate pass-through: correlation of y-o-y CPI with lagged nominal effective exchange rate changes.
- Key country indicators (as reported):
  - Dollarization index: Pakistan (9); Kazakhstan (7).
  - Correlation real GDP and NEER (1993-2003): Pakistan (0.52); Kazakhstan (0).
  - Correlation NEER and CPI (1993-2003): Pakistan (-0.27); Kazakhstan (-0.64).
- Conclusions:
  - Pakistan: moderate degree of dollarization and little evidence of unusually high pass-through → modest case for a peg on fear-of-floating grounds (some evidence that depreciation is contractionary).
  - Kazakhstan: relatively low historical dollarization and limited evidence of balance-sheet effects historically → neutral case (but recent developments may change this).

### Scorecard (summary of findings for Pakistan and Kazakhstan)
- Aggregate assessment for Pakistan (based on historical data and template):
  - Fairly strong case against pegging the rupee.
  - Main reasons:
    - High integration with global financial markets → exposure to volatile private capital flows and risks under a peg.
    - High dependence on cotton → need for exchange rate adjustment to commodity price shocks.
    - Real shocks dominate nominal shocks → peg not advantageous for stabilization.
    - Low external trade orientation → limited trade gains from a peg.
    - Caveat: some evidence that rupee depreciation can be contractionary (fear-of-floating), but corporate dollar borrowing is limited, weakening balance-sheet arguments for a peg.
- Aggregate assessment for Kazakhstan (based on historical data and adjusted for recent changes):
  - Historical scorecard: mixed case for a peg.
  - Adjustments based on recent changes strengthen the case against a peg:
    - Rapid increase in external borrowing by private sector and rising monetization → greater international financial integration and vulnerability to capital flow volatility.
    - Sustained reduction of inflation to single digits → diminished nominal anchor benefits from a peg.
    - Continued commodity dependence and large real shocks → costs from foregoing exchange rate adjustment remain significant.
    - Dollarization rose after the Russian crisis and private external borrowing increased in 2004–05 → potential resurgence of fear-of-floating effects, which could strengthen arguments for a peg in the short term.
  - Net implication: moving toward greater exchange rate flexibility is advisable to contain financial risks and facilitate adjustment.

### Conclusions and policy implications
- The template provides an operational scorecard to assess whether a country’s de facto exchange rate regime is consistent with economic and financial considerations.
- Pakistan: evidence of “fear of floating” in practice, but the template indicates that a peg is not advantageous given Pakistan’s characteristics — increased exchange rate flexibility is likely to improve performance.
- Kazakhstan: transition-era instability limited pegging; as stability improved a de facto peg emerged, but more recent financial integration, lower inflation, and evolving trade patterns make a stronger case for increased flexibility going forward.
- General observation: trade-offs across considerations are common; country-specific prioritization of factors remains necessary.

*Source: Chapter 7, “Fear-of-Floating Effects,” IMF Working Paper _wp0654 (figures and tables as presented in the source).*

### References

### References

### Listed works
- Aghevli, Bijan B., Mohsin S. Khan, and Peter J. Montiel, 1991, Exchange Rate Policy in Developing Countries: Some Analytical Issues, IMF Occasional Paper No. 78 (Washington: International Monetary Fund).
- Calvo, Guillermo A., and Carmen M. Reinhart, 2002, “Fear of Floating,” Quarterly Journal of Economics, Vol. 117 (May), pp. 379–408.
- Edison, Hali J., and Michael Melvin, 1990, “The Determinants and Implications of an Exchange Rate System,” in Monetary Policy for a Volatile Global Economy, ed. by William S. Haraf and Thomas D. Willett (Washington: AEI Press).
- Edwards, Sebastian, and Miguel A. Savastano, 1999, “The Choice of Exchange Rate Regimes in Developing and Middle Income Countries,” in Changes in Exchange Rates in Rapidly Developing Countries: Theory, Practice, and Policy Issues, ed. by Takatoshi Ito and Anne O. Krueger, NBER-East Asia Seminars on Economics, Vol. 7 (Chicago and London: University of Chicago Press).
- Eichengreen, Barry, Paul Masson, and others, 1998, Exit Strategies: Policy Options for Countries Seeking Greater Exchange Rate Flexibility, IMF Occasional Paper No. 168 (Washington: International Monetary Fund).
- Frankel, Jeffrey A., 2003, “A Proposed Monetary Regime for Small Commodity Exporters: Peg the Export Price,” Harvard University Faculty Research Working Papers Series.
- ———, and Andrew Rose, 2002, “An Estimate of the Effect of Common Currencies on Trade and Income,” Quarterly Journal of Economics, Vol. 117 (May), pp. 437–66.
- Ghosh, Atish R., Anne-Marie Gulde, and Holger C. Wolf, 2002, Exchange Rate Regimes: Choices and Consequences (Cambridge, Massachusetts: MIT Press).
- Husain, Aasim M., 2006, “Choosing the Right Exchange Rate Regime for Pakistan,” State Bank of Pakistan Research Bulletin, forthcoming.
- ———, Ashoka Mody, and Kenneth S. Rogoff, 2005, “Exchange Rate Regime Durability and Performance in Developing Versus Advanced Economies,” Journal of Monetary Economics, Vol. 52 (January), pp. 35–64.
- Juhn, Grace S., and Paolo Mauro, “Long-Run Determinants of Exchange Rate Regimes: A Simple Sensitivity Analysis,” IMF Working Paper No. 02/104 (Washington: International Monetary Fund).
- Mussa, Michael, Paul Masson, Alexander Swoboda, Esteban Jadresic, Paolo Mauro, and Andrew Berg, 2000, Exchange Rate Regimes in an Increasingly Integrated World Economy, IMF Occasional Paper No. 193 (Washington: International Monetary Fund).
- Reinhart, Carmen M., and Kenneth S. Rogoff, 2004, “The Modern History of Exchange Rate Arrangements: A Reinterpretation,” Quarterly Journal of Economics, Vol. 119 (February), pp. 1–48.
- ———, and Miguel A. Savastano, 2003, “Addicted to Dollars,” NBER Working Paper No. 10015 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Rogoff, Kenneth S., Aasim M. Husain, Ashoka Mody, Robin Brooks, and Nienke Oomes, 2004, Evolution and Performance of Exchange Rate Regimes, IMF Occasional Paper No. 229 (Washington: International Monetary Fund).
- Rose, Andrew, 2000, “One Money, One Market? The Effect of Common Currencies on International Trade,” Economic Policy, Vol. 30, pp. 7–45.

*Source: _wp0654 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2006/_wp0654.pdf_