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Paul Cashin, Luis C�spedes, and Ratna Sahay
Developing countries reliant on commodity exports see the fate of their exchange rates tied to fickle commodity markets
For decades, economists have tried with little success to model long-run movements in real—that is, adjusted for inflation—exchange rates. Almost all of the studies have focused on industrial countries, trying to pinpoint whether fundamentals such as government spending, current account imbalances, and differences in productivity and interest rates hold the key to explaining exchange rate movements. But the results have been disappointing, with many models that are based on fundamentals failing to provide a convincing explanation of the behavior of real exchange rates in industrial countries.
In contrast, studies of the behavior of developing country real exchange rates are scarce. The few studies that have examined the determinants of these rates have focused largely on Latin America and have emphasized the role of terms of trade movements in driving the real exchange rate. However, a natural assumption for developing countries is that fluctuations in real commodity prices have the potential to explain a large share of changes in real exchange rates, given that so many of these countries are highly dependent on commodities—in some cases, a single commodity—for the bulk of their export revenues. Indeed, several studies have explored this relationship for a handful of commodity-exporting industrial countries, such as Australia, Canada, and New Zealand. But the biggest hurdle in extending these studies to developing countries has been the lack of country-specific data on commodity export prices.
That is why we undertook a study of the relationship between the real exchange rate and real commodity prices for all commodity-dependent economies. We asked two questions: Do real commodity prices and real exchange rates move together? And does the exchange regime affect a country's ability to cope with commodity price swings? The findings are surprising and raise serious questions for policymakers, given that the real exchange rate holds the key to a country's competitiveness in global trading markets.Identifying commodity currencies
Our study began with the construction of new monthly indices of national real commodity export prices and the gathering of monthly real exchange rate data for 58 commodity-exporting countries for the period January 1980 to March 2002. Each country's (nominal) commodity export price index is a geometric weighted average of world prices for 44 individual nonfuel commodities (taken from IMF commodity price data), using country-specific export shares (averaged over 1990–99) as weights. The national indices of the nominal (U.S. dollar) price of nonfuel commodity exports are then deflated by the IMF's measure of the nominal (U.S. dollar) price of exports of manufactured goods to form the real price of commodity exports for each country. The real price of commodity exports can also be described as a measure of the terms of trade of each country, expressed in world prices. The real exchange rate is the IMF's real effective exchange rate, which is defined for each country as the trade-weighted average of bilateral exchange rates vis-�-vis trading partners' currencies, adjusted for price differentials between the home country and trading partners.
The 58 commodity-exporting countries include 53 developing countries (classified by the IMF's World Economic Outlook as exporters of nonfuel primary products and those with diversified export earnings) and 5 industrial countries—all of which rely on commodity exports for a major share of their export income. Indeed, during the 1990s, the cross-country mean share of total export receipts derived from primary commodity exports was about 48 percent. Commodity exports typically exceeded 50 percent of the total exports of several sub-Saharan African countries, especially Burundi (97 percent), Madagascar (90 percent), and Zambia (88 percent). The share of primary commodity exports in total exports was quite high even for the industrial countries (Australia, 54 percent; Iceland, 56 percent). In addition, many countries remain overwhelmingly dependent on export receipts from their dominant exportable commodity—the dominant exportable exceeded 90 percent of commodity export receipts in Dominica (bananas), Ethiopia (coffee), Mauritius (sugar), Niger (uranium), and Zambia (copper).
Armed with the real exchange rate and real commodity export prices for each country, we then checked to see whether these two series displayed a close relationship. We found that, for many countries, such as Australia and Burundi (both of which have flexible nominal exchange rates), this was indeed the case (see chart), while others appear to display a relationship once a onetime movement in the real exchange rate (such as the 1994 devaluation for the CFA franc zone countries of Mali and Togo) is accounted for.
Next, we used regression analysis to formally examine whether there was a stable, long-run relationship between a country's real exchange rate and the real price of its commodity exports—in other words, which of the commodity-exporting countries qualified as having "commodity currencies"? In the analysis, we allowed for a structural shift in the relationship between the two series to account for onetime movements in either series (which typically involve rapid movements in the nominal (and real) exchange rate). We found just such a long-run relationship for 22 of the 58 commodity-exporting countries (Table 1). It is not unexpected that sub-Saharan African countries, given their dependence on commodity exports, account for half the commodity-currency countries. Moreover, for these 22 countries, over 80 percent of the variation in the real exchange rate can, on average, be accounted for by movements in real commodity prices alone—a surprisingly strong result. As for those commodity-exporting countries where such a long-run relationship could not be found, it is likely that factors other than real commodity prices played a key role in real exchange rate movements.