Keynote Address by IMF African Department Director Abebe Aemro Selassie at the 45th Assembly of Governors Association of African Central Banks
IMF News, August 3, 2023
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Bibliographic details
- Published: August 3, 2023
Context and caveats
- Occasion: Keynote Address at the 45th Assembly of Governors Association of African Central Banks; delivered August 3, 2023.
- Scope limitations emphasized by speaker:
- Focus of intervention relates to cases where the exchange rate regime is flexible.
- Remarks are necessarily general given “huge heterogeneity of circumstances, institutions, policies across the region.”
- Priority on outcome variables over intermediate measures of misalignment.
Why focus on exchange rate calibration now?
- Four broad reasons motivate scrutiny of monetary and exchange rate policy calibration over recent years (overview given in the speech).
- Key observations and empirical points raised:
- Export performance:
- Between 2000 and 2019, the share of SSA countries in global exports moved from 1.5 to 1.7 percent of total global exports.
- Current account deficits:
- Since the turn of the century (and more so since around the end of the global financial crisis) current account deficits in the region have been persistently elevated.
- Chart reference: Sub-Saharan Africa: Current Account Balance, 2000-19 (Median, percent of GDP).
- Growth and external orientation:
- Growth is typically stronger and more sustained when it has a strong element of export orientation.
- Growth decomposition (2000–23) shows the contribution of exports to growth in the region has been less than in comparator developing countries (comparators include Bangladesh, India, and Vietnam).
- Recent shocks and reserve pressures (last 2 years):
- Countries have been shut out of capital markets, cost of funding has shot up, and terms of trade deteriorated for the vast majority of countries.
- Significant exchange rate depreciation has occurred across the region but “the extent of depreciation has not been sufficient.”
- Pronounced decline in foreign exchange reserves noted; central banks have often sold reserves rather than allowing exchange rate depreciation.
- References to figures:
- Sub-Saharan Africa: Exchange Rates vs U.S. Dollar, Sep. 2021–Jun. 2023 (Sep 1, 2021=100, trade-weighted mean).
- Exchange Rate vs U.S. Dollar (Percent change, triangle = Global Financial Crises, square = Taper Tantrum, dots with bar = end-2021 to June 29, 2023).
- Sub-Saharan Africa: International Reserves (Months of imports, group median).
- Sub-Saharan Africa: Exchange Rate Pressure Index, 2022 (Index score; index scores are calculated for each year and normalized by the standard deviation of the previous 9 years).
Five common arguments for resisting depreciation and counter-arguments
- Overview: Speaker outlines five main arguments often made for resisting depreciation pressures and provides counterpoints.
- A. “The exchange rate is the most important nominal anchor”
- Argument: Exchange rate visibility anchors expectations, planning, investment, and consumption; large moves are disruptive.
- Counters:
- Persistent reserve depletion: interventions risk exhausting reserves and merely delay inevitable adjustment.
- Fiscal and monetary tightening to offset depreciation may be infeasible or undesirable.
- Re-emergence of quantitative restrictions (import bans, limits on FX access) undermine investment and growth and allocate scarce resources inefficiently.
- B. “Depreciations exacerbate inflationary pressures”
- Argument: Depreciation raises imported goods prices; with fuel and food import dependence plus global inflation, pass-through to domestic prices is likely substantial; inflation has surged to levels last observed in the 1990s.
- Counter: Pass-through depends on overall monetary and fiscal conditions; effectiveness of FX intervention to limit pass-through is contingent on credible macro policy settings, particularly monetary policy credibility.
- C. “Depreciations are contractionary”
- Argument: Devaluations raise import costs, reduce investment and consumption, and can curtail production; past depreciations (1980s) did not necessarily boost exports due to small export sectors and structural impediments.
- Counters:
- Depreciation pressures typically occur with current account deficits; avoiding adjustment requires increased capital inflows (external borrowing) which are pro-cyclical and retract during adverse shocks.
- Borrowing to sustain an overvalued exchange rate must be repaid, implying future internal rebalancing.
- Empirical evidence exists that undervaluing the exchange rate can be more helpful for sustaining growth.
- Asymmetric effects: observable losers from depreciation are vocal, while prevented beneficiaries from prior overvaluation remain unaccounted for.
- D. “Depreciations have large adverse balance sheet effects”
- Argument: Depreciation raises local currency value of external liabilities for corporates, households, and public sector; can aggravate debt-servicing burdens and precipitate financial crises (examples cited globally: Mexico 1994, Thailand 1997, Indonesia 1997).
- Counters:
- Depreciation is rarely the sole cause of debt unsustainability; longer-term drivers are years of high fiscal deficits often coupled with overvalued exchange rates.
- Delaying depreciation to mask public debt problems postpones inevitable adjustments at the expense of growth.
- Central bank valuation effect: central banks with local-currency liabilities gain positive valuation on FX reserves during depreciation, which can hedge public sector FX debt.
- E. “Depreciations cause social and political upheaval”
- Argument: Exchange rate is a visible barometer of national economic wellbeing; depreciation has distributional consequences and political significance.
- Counters and recommended approaches:
- Communicate trade-offs clearly: weigh short-term costs against longer-term costs of maintaining overvaluation; explain competing interests of import-dependent vocal groups versus activities stifled by misaligned exchange rates.
- Mitigation measures: increase transfers to poorest and most vulnerable households in the immediate aftermath of large depreciations.
Policy implications and recommendations
- General stance: Call for pragmatism and learning from regional and international experience rather than ideological adherence.
- Specific policy-relevant points:
- Avoid prolonged FX intervention that depletes reserves and postpones necessary adjustment.
- Recognize that credible monetary and fiscal policy settings are central to managing pass-through and inflation outcomes.
- Account explicitly for depreciation scenarios in forward-looking debt sustainability assessments; where needed, pursue restructuring rather than masking vulnerabilities.
- Use targeted social protection measures (e.g., increased transfers) to shield poorest households following large depreciations.
- Refrain from administrative quantitative restrictions as they undermine investment, transparency, and efficient resource allocation.
- Improve communication to manage political economy constraints and explain the distributional trade-offs of exchange rate choices.
Concluding remarks
- Speaker reiterates respect for the difficult trade-offs faced by policymakers in African countries and emphasizes:
- The call is to avoid certain policy choices—specifically, efforts to resist depreciation pressures when depreciation is warranted and the cost of avoiding it is high.
- Pragmatism and learning from experience should guide exchange rate and monetary policy design.
- Closing image: proverb: “for fear of a dog bite, better to not run towards the hyena.”
Keynote Address by IMF African Department Director Abebe Aemro Selassie at the 45th Assembly of Governors Association of African Central Banks, August 3, 2023.