FX International Payments
By Frances Coppola
However, the extent of that dollar exchange rate fall varies from country to country. At the top of the list are Turkey and Argentina, both of which have suffered “sudden stops” – when capital inflows into a country plummet to virtually zero. But several more currencies also have experienced exchange rate falls of 10 percent or more, including the South African rand, the Indonesian rupiah, and the Brazilian real.
Each of these countries has unique economic issues, but they also share some similar vulnerabilities. U.S. businesses contemplating trade with these countries may wish to be aware of all these concerns.
The dollar exchange rate of South Africa’s rand dropped by 14.5 percent between January and October 2018, the third largest fall among developing-country currencies.2 Partly, this was because of South Africa’s brief recession in the first half of 2018.3 However, three specific vulnerabilities in the South African economy also contributed to the rand’s weakness.
The first vulnerability is South Africa’s current account deficit, which widened sharply in 2018, peaking at 4.6 percent of GDP in June.4 Although South Africa usually runs a trade surplus, relatively high interest rates on its external debt mean that it pays more to foreign investors than South African residents receive in income from foreign investments. Consequently, it has a large and persistent primary income deficit.5 The need to finance the primary income deficit in dollars makes South Africa vulnerable to FX crisis. The rising U.S. dollar makes obtaining dollars more expensive in terms of the rand, which discourages foreign investors from holding dollar-denominated debt issued by South African corporations. This partly explains the weakness of the rand.
Second, South Africa’s FX reserves have declined during the course of 2018.6 Low FX reserves increase the risk that South Africa will be unable to meet its dollar obligations, therefore making investors less willing to hold dollar-denominated debt.
And finally, there is the government’s persistent fiscal deficit, typically 4-5 percent of GDP. Investors worried about inflation arising from the persistent deficit may sell government debt, causing bond yields to rise and the rand to weaken. Bond yields have risen steadily since April 2018,7 paralleling the rand’s dollar exchange rate fall.8
This trio of economic factors constitute the principal drivers of the rand’s declining dollar exchange rate.
Although the Indonesian economy has grown strongly in 2018,9 the rupiah’s dollar exchange rate fell by 10.7 percent between January and October 2018.10 To some extent, this is because of historical uncertainty about the rupiah’s value. The rupiah’s exchange rate has been highly volatile ever since its dramatic collapse in the Asian crisis of 1997, so it tends to respond strongly to general turbulence in FX markets.11
Indonesia runs twin fiscal and current account deficits. However, as its fiscal deficit is small – about 2 percent of GDP – analysts don’t see it as much of a risk.12 The current account deficit is bigger and has widened sharply in 2018.13 Some analysts see this as a contributory factor in the rupiah’s exchange rate fall.14
But the real problem is external debt. Indonesia’s external debt has grown faster than GDP in 2018, reflecting the widening current account deficit. At the end of the second quarter, it stood at $355.7 billion, approximately 34 percent of GDP. Most of it is denominated in foreign currencies, of which USD is by far the largest proportion. About half of it is government debt.15
The widening current account deficit and high dollar-denominated external debt raise the risk of FX crisis or even a sudden stop. As a result, investors are becoming reluctant to hold assets issued by the Indonesian government or private sector, regardless of the currency in which they are denominated. This explains most of the rupiah’s dollar exchange rate weakness.
The Brazilian real’s dollar exchange rate dropped by 10.8 percent in the first nine months of 2018.16 Some analysts have presented Brazil’s currency exchange rate decline as a “battle” between the central bank and FX speculators.17 But currency speculators are attracted by weaknesses in Brazil’s economy that in their view justify a significantly lower exchange rate.
Brazil experienced a sudden stop and deep recession in 2015-16, from which it is only slowly emerging. GDP growth in 2017 was 1 percent, and the outlook for 2018 and 2019 is not much better. In July 2018, the International Monetary Fund (IMF) projected growth of 1.8 percent for 2018 and 2.5 percent in 2019, which is low by developing country standards.18 Low growth is putting pressure on Brazil’s finances. Although the primary fiscal deficit is below 2 percent of GDP, debt is already at 77 percent of GDP,19 and the IMF expects it to peak at 90 percent of GDP in 2023, even if there is no net increase in spending.20 A poor growth outlook coupled with rising debt tends to make risk-averse investors reluctant to hold Brazilian government bonds, while rising yields on U.S. Treasuries make them more attractive as alternatives to Brazilian bonds for investors looking for yield. Lower demand for Brazilian bonds weakens the real’s currency exchange rate.
As a result of the sudden stop, the current account shrank from 4.2 percent of GDP in 2017 to 0.5 percent in 2017. However, as Brazil returns to growth, some are concerned that the current account deficit could widen and external debt rise.21 This also tends to put downward pressure on the real’s exchange rate.
Additionally, U.S. interest rate rises are reducing the attractiveness of the Brazilian real as a lending currency for carry trades.22 Consequently, investors have sold off Brazilian government bonds, increasing their yields and weakening the real’s exchange rate. The central bank has taken steps to stem the outward flow of capital without raising interest rates.23
The tussle between the central bank and speculators principally concerns inflation. The central bank says inflation is firmly anchored around its 4 percent target.24 On these grounds, in September it refused to raise interest rates.25 It remains to be seen whether the central bank’s assertive attitude will be sufficient to support the real. Many analysts think that fundamental fiscal reforms to bring down the debt-to-GDP ratio will be needed.26
Brazil, Indonesia and South Africa each have their own economic issues affecting their currencies’ dollar exchange rate. But common to them all – to varying degrees – are fiscal and/or current account deficits and high public and/or private debt. These raise the risk of FX crisis, already amplified by the strong dollar. Exchange rate volatility for these currencies could remain high while the U.S. continues to tighten monetary conditions.
With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.
1. “Emerging Market Currencies Versus The U.S. Dollar,” Thomson Reuters; http://fingfx.thomsonreuters.com/gfx/breakingviews/1/853/1102/DataStream-Chart.htm
3. “Breaking: South Africa slips into technical recession, GDP dips by 0.7%,” The South African; https://www.thesouthafrican.com/south-africa-recession-gdp-decrease-q2-2018/
4. “South Africa Current Account Percent Of GDP,” Investing.com; https://za.investing.com/economic-calendar/south-african-current-account--of-gdp-1352
5. “Balance of payments: current account of the balance of payments,” South African Reserve Bank; https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8745/Current%20account%20release%20-%20September%202018.pdf
6. “Information notice on the official gold and foreign exchange reserves of the South African Reserve Bank,” South African Reserve Bank; https://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/8817/GoldFXReserves_September%202018.pdf
7. “South Africa 10-year Bond Yield,” Investing.com; https://www.investing.com/rates-bonds/south-africa-10-year-bond-yield
8. USDZAR, Bloomberg; https://www.bloomberg.com/quote/USDZAR:CUR
9. “Economy of Indonesia: GDP Growth at 5.27 In Q2 2018 Tops Estimates,” Indonesia Investments; https://www.indonesia-investments.com/news/news-columns/economy-of-indonesia-gdp-growth-at-5.27-in-q2-2018-tops-estimates/item8926
10. “Emerging Market Currencies Versus The U.S. Dollar,” Thomson Reuters; http://fingfx.thomsonreuters.com/gfx/breakingviews/1/853/1102/DataStream-Chart.htm
11. “Rupiah at lowest since Asian financial crisis, but Indonesia keeps calm and carries on,” South China Morning Post; https://www.scmp.com/week-asia/economics/article/2167208/rupiah-lowest-asian-financial-crisis-indonesia-keeps-calm-and
12. “Despite Deviations Indonesia Won’t Revise the 2018 State Budget,” Indonesia Investments; https://www.indonesia-investments.com/finance/financial-columns/despite-deviations-indonesia-won-t-revise-the-2018-state-budget/item8889
13. “Current Account Deficit Hits 4-Year High In Second Quarter,” Jakarta Globe; https://jakartaglobe.id/business/current-account-deficit-swells-to-near-4-year-high-in-new-blow-for-rupiah/
14. “Indonesia Sees Widening Current Account Deficit In Q2 2018,” Indonesia Investments; https://www.indonesia-investments.com/finance/financial-columns/indonesia-sees-widening-current-account-deficit-in-q2-2018/item8940
15. External Debt Statistics of Indonesia – October 2018,” Bank Indonesia; https://www.bi.go.id/en/iru/economic-data/external-debt/Pages/SULNI-Oktober-2018.aspx
16. “Emerging Market Currencies Versus The U.S. Dollar,” Thomson Reuters; http://fingfx.thomsonreuters.com/gfx/breakingviews/1/853/1102/DataStream-Chart.htm
17. “Brazil’s central bank in firepower test with currency speculators,” Financial Times; https://www.ft.com/content/7b00dbe4-6ddf-11e8-92d3-6c13e5c92914
18. “IMF Executive Board Concludes Article IV Consultation With Brazil,” International Monetary Fund; https://www.imf.org/en/News/Articles/2018/07/11/pr18288-imf-executive-board-concludes-2018-article-iv-consultation-with-brazil
19. “Fiscal statistics,” Banco Central Do Brazil; https://www.bcb.gov.br/ingles/notecon3-i.asp
21. “IMF Executive Board Concludes Article IV Consultation With Brazil,” International Monetary Fund; https://www.imf.org/en/News/Articles/2018/07/11/pr18288-imf-executive-board-concludes-2018-article-iv-consultation-with-brazil
22. “Brazil’s weaker currency suggests fading of carry trade appeal,” Financial Times; https://www.ft.com/content/fe87df74-430c-11e8-803a-295c97e6fd0b
23. “Brazil’s central bank in firepower test with currency speculators,” Financial Times; https://www.ft.com/content/7b00dbe4-6ddf-11e8-92d3-6c13e5c92914
24. “217th meeting of the Monetary Policy Committee of the Central Bank of Brazil – Press Release,” Banco Central Do Brasil; https://www.bcb.gov.br/en/#!/c/news/1859
25. “Brazil Central Bank Leaves Selic Rate Unchanged At 6.5%,” Wall Street Journal; https://www.wsj.com/articles/brazil-central-bank-leaves-selic-rate-unchanged-at-6-5-1537395998
26. “Brazil’s central bank in firepower test with currency speculators,” Financial Times; https://www.ft.com/content/7b00dbe4-6ddf-11e8-92d3-6c13e5c92914