Saturday, June 10

Dollar: how far behind is the real exchange rate? (according to the IIF)

The verdict of the work signed by the economists Robin Brooks, Jonathan Fortun and Jack Pingle shows that, by way of summary, they found large undervaluations in the cases of Brazil, China, Turkey and many emerging currencies in Asia, and the path of face substantial overvaluations for Argentina, Colombia, Egypt, India, Mexico and South Africa. At first glance, we see that Argentina is in trouble, since not only is its currency appreciated, but that of its main Mercosur partner is also depreciated. How many? We’ll see.


What the IIF has been doing since the beginning of 2018, when they first pointed out substantial overvaluations for the Turkish lira and the Argentine peso, is calculating “fair values” of emerging currencies. For this they use the approach based on the current account.

They adjust this current account for the lagged effects of previous movements in the exchange rate and make a cyclical adjustment, based on the evaluation of the local and external production gaps. The last step is especially important in the current juncture, given that current accounts moved sharply during covid, largely due to temporary drops in domestic demand, which they control by “closing” output gaps.

The model filters out these cyclical changes in current accounts and it is the remaining underlying current account, adjusted for exchange rate movements and cyclical factors, that is then compared to an equilibrium norm for the saving-investment balance.

The IIF economists highlight that while the defining characteristic of many emerging currencies is that over the last decade they have fallen sharply in real effective terms (on a trade-weighted basis and taking inflation into account), and under the traditional model based on in the PPP would invariably indicate large undervaluations given these falls, that is not necessarily the case of the IIF model, precisely because the main input of the model is the current account.

In the case of Argentina, the equilibrium balance or objective of the current account for this year is calculated at 3% of GDP and they determine that there is an overvaluation of the real exchange rate of almost 23%, that is, it is the necessary real effective exchange rate. to bring the current account to the proper level.

For example, in the case of Brazil, the current account balance would be negative by 2% of GDP and the real is undervalued by almost 21%. In other words, the peso would have to depreciate more than 20 points above inflation, while the real would have to appreciate by almost the same magnitude. “We find large undervaluations for Brazil, China, Turkey and many emerging Asian currencies, while there are substantial overvaluations for Argentina, Colombia, Egypt, India, Mexico and South Africa,” says the IIF.

For example, among the largest exchange rate misalignments in the region, apart from Argentina, Colombia stands out with more than 12% and Mexico and Ecuador with almost 11%. So in the eyes of these analysts, who are well acquainted with the IMF technicians and their evaluation methodologies, the competitiveness of the peso is in check. This is how 2022 begins in exchange matters and in the midst of a pending agreement with the IMF.