Countries Looking to Devalue Their Way to Growth Have a Big Problem, HSBC Says
by Luke Kawa
Currency depreciations just don’t have the impact they used to.
Economists at HSBC have a message for monetary policymakers who are hoping their stimulus will help devalue their local currencies and spur exports: Good luck with that.
According to HSBC Global Chief Economist Janet Henry and Economist James Pomeroy, a depreciating currency just doesn’t pack the same punch it used to.
Since the 2008 global financial crisis, “there has so far been little evidence that any major region has benefited from a weaker exchange rate for any significant period,” write the economists. “A World Bank study of developed and emerging economies recently found that even for the devaluing countries the currency declines between 2004 and 2012 were only half as effective at boosting exports as they had been in the previous eight-year period.”
Accommodative monetary policy generally works through two channels: Interest rate cuts increase the incentive for businesses to borrow money, and the decline in the exchange rate that typically accompanies such rate cuts makes the goods and services produced by a nation more attractive to foreign buyers.
With consumers in some nations looking more and more tapped out, the need to rebalance growth toward external drivers has become more urgent.
But there’s one big fly in the ointment: the well-publicized slowdown in global tradegrowth.
Competitive devaluations may be both a cause and symptom of this development.
A desire to tap into external demand in the face of a weakening domestic economy may prompt a central bank to increase the amount of accommodation it is providing. But Henry and Pomeroy, citing the World Bank’s research, note that the improvement in a nation’s trade balance attributable to foreign exchange depreciation comes primarily through import compression.
If countries whose currencies have declined see their trade balances improve via lower imports—and this dynamic happens en masse—it logically follows that export growth is going to be particularly difficult to come by. In fact, in aggregate, it will not occur. Such would be the case in an environment in which every nation tried to use a lower currency as a mechanism to export its way to prosperity.
Competitive devaluations are therefore often referred to as “beggar thy neighbor” measures, in which a country with a lower currency takes a bigger slice of the export pie at the expense of another nation in a zero-sum game.
But HSBC’s economists take things a step farther, writing that overall, this could be a negative-sum game.
“At a minimum a weaker currency can sometimes take the pressure off governments to deliver structural reforms which might boost long-term growth,” write Henry and Pomeroy. “Currency volatility can also fuel uncertainty.”
In other words, this is at best a band-aid solution. Moreover, a weaker currency discourages companies from making productivity-enhancing investments, especially in the event that this would require them to import goods.
Some countries, the pair notes, have had experiences in which a decline in their exchange rate has been followed by relatively buoyant export growth, like the U.S. in 2009-10, Japan in 2013-14, and the euro zone in the runup to quantitative easing. There are better explanations, however, for the jump in shipments during those periods.
For the U.S. and Europe, the export performance was in line with foreign demand from major trading partners, while in the case of Japan, one can point to the resolution of its dispute with China as the cause of a rebound.
“This all underlines the much greater importance of external demand growth than FX moves in driving export growth,” the economists conclude.