Exchange market pressures in the EBRD’s countries of operations

By: Asset Irgaliyev, Economic Analyst and Alex Pivovarsky, Senior Economist

The new bout of the global economic uncertainty and falling demand in the core markets have recently increased external pressures on the economies of the Bank’s countries of operation. We want to measure exchange market pressure in the recent turbulence and compare it to the pressures experienced in the region in 2008-09.

For this exercise, one must look at both exchange rate and reserve movements. In some cases, external pressures have led to depreciations of the local currencies. In others, they have culminated in loss of foreign currency reserves by central banks.

To be able to compare the extent of external pressures on economies, we designed an index of exchange market pressure (EMP), which is a simple average of two indices: a Nominal Effective Exchange Rates (NEER) index and an International Reserves (IR) index.[1] Both NEER and IR indices are updated each month using a moving average for the previous 12 months as a reference period to ensure one-off or seasonal movements are eliminated.

When the EMP index is below 1, it indicates that either the exchange rate is depreciating or central bank reserves are falling, or both. Conversely, a value above 1 means exchange rate appreciation and/or reserve accumulation. Of course, in some cases this may also represent a drawdown of IMF resources by the central banks or other one-off inflows.[2]

The EMP shows that external pressures have increased since September 2011 in many of the Bank’s countries of operations. Thus, the indices for Hungary, Poland, Russia, Turkey, and Ukraine are now at about the levels where they were at the onset of the 2008-9 crisis, in the autumn of 2008 (see Figure 1). In the cases of Hungary and Turkey, the indices were below 1 for the first time since then. Most likely by now, this is also the case for the other three countries.

 Figure 1. Dynamics of EMP Index for selected countries of operation.

 

Note: EMP= 0.5(NEER) + 0.5(IR), where NEER and IR indices are derived based on 12-month moving averages of nominal effective exchange rate and international reserves, respectively. Low values of EMP indicate significant nominal depreciation and/or falling international reserves.

However, the pressures are not yet as severe as they were at the peak of the crisis in the spring of 2009 (see Figure 2).  At that time, external pressures have led to significant loss of reserves and devaluations in many countries, with indices falling to as low as 0.75-0.8.

A number of commodity rich countries (including Azerbaijan and Russia) lost significant shares of their external reserves. Some others (for example, Ukraine) suffered from large devaluations.At this stage, Belarus is the only country which has surpassed the intensity of exchange market pressures experienced in 2008-9.

Belarus is in the midst of a largely home-growth balance of payments crisis. Hungary has somewhat surprising trajectories in both crises.It seems to have had early onset but was able to handle the crisis early on in 2008 by tapping the EU and IMF resources.

This year’s experience is perhaps somewhat similar, but the increase of the index may reflect the depreciation of the US dollar vis-à-vis the euro and Swiss franc before the new wave of the global instability started in August 2011, as Hungary holds most if its reserves in these currencies while the EMP is based on reserves measured in US dollars.

Figure 2.Comparison of EMP indices in October 2011 with March 2009.

 

[1] The use of nominal effective exchange rates for all countries (including with currency boards and pegged exchange rates) ensures that exchange rates movements reflect pressures vis-à-vis exchange rates of the main trading partners.

Thus, a country pegging its currency to US dollar but trading primarily with the eurozone would experience effective appreciation pressure when US dollar appreciates vis-à-vis the euro that would offset some of the related reserve loss.

[2] The index does not capture the impact of possible capital controls, used by some countries in the latest crisis.

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