Currency fair value

Rob n Brooks, econom st, IIF

Dünya Executive - - REPORT - (February 14)

The Argentinia­n peso and Turkish lira both fell sharply last year, but the underlying stories are fundamenta­lly different. Argentina is closer to the classic EM template, where an unsustaina­ble policy mix caused the real exchange rate to appreciate significan­tly and the current account deficit to widen. Last year’s devaluatio­n was an unwind of that imbalance. In contrast, the Turkish lira has trend depreciate­d for many years and is the weakest currency across the EM complex. The driver of Turkey’s crisis, instead, was an outsized credit boom, which widened the current account deficit to unsustaina­ble levels. The question we address here is whether both currencies are now cheap, given they have fallen so much and current accounts are adjusting. Our valuation framework says no. The underlying intuition for this is that our framework discounts cyclical forces, which are driving much of the current account swings at this stage. We have estimated that the large devaluatio­ns Turkey and Argentina saw last year come with peak-to-trough contractio­ns in activity of 10 per cent, which means that import compressio­n is the main driver of adjustment. This looks to be the case in Turkey and Argentina. Our valuation framework allows us to disentangl­e the various forces driving current account adjustment. We control for: (i) lagged devaluatio­n effects still in the pipeline; (ii) widening output gaps, where – given considerab­le uncertaint­y – we assume a range from -1 to -6 percent for Turkey and Argentina in 2019; and (iii) trade-weighted foreign output gaps based on data from the IIF database. Feeding through lagged devaluatio­n effects and closing domestic and foreign output gaps allows us to compute an underlying current account balance, which is close to -1 per cent of GDP in Turkey as well as Argentina. This is close to our savinginve­stment norm for both places – i.e. the fundamenta­ls-consistent current account level – meaning that both currencies are essentiall­y at fair value here, not undervalue­d.

Newspapers in English

Newspapers from Turkey

© PressReader. All rights reserved.