Brad Setser

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Cross border flows, with a bit of macroeconomics

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Showing posts for "emerging economies"

Won Appreciates, South Korea Intervenes

by Brad Setser

South Korea’s tendency to intervene to limit the won’s appreciation is well known.

When the won appreciated toward 1100 (won to the dollar) last week, it wasn’t that hard to predict that reports of Korean intervention would soon follow.

Last Thursday Reuters wrote:

“The South Korean currency, emerging Asia’s best performer this year, pared some gains as foreign exchange authorities were suspected of intervening to stem further appreciation, traders said. The authorities were spotted around 1,101, they added. ”

The won did appreciate to 1095 or so Tuesday, when the Mexican peso rallied, and has subsequently hovered around that level. It is now firmly in the range that generated intervention in August.

won-dollar

The South Koreans are the current masters of competitive non-appreciation. I suspect the credibility of Korea’s intervention threat helps limit the scale of their actual intervention.

And with South Korea’s government pension fund now building up foreign assets at a rapid clip, the amount that the central bank needs to actually buy in the market has been structurally reduced. Especially if the National Pension Service plays with its foreign currency hedge ratio to help the Bank of Korea out a bit (See this Bloomberg article; a “lower hedge ratio will boost demand for the dollar in the spot market” per Jeon Seung Ji of Samsung Futures).

Foreign exchange intervention to limit appreciation isn’t as prevalent it once was. More big central banks are selling than are buying. But it also hasn’t entirely gone away.

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The Most Interesting FX Story in Asia is Now Korea, Not China

by Brad Setser

China released its end-August reserves, and there isn’t all that much to see. Valuation changes from currency moves do not seem to have been a big factor in August, the headline fall of around $15 billion is a reasnable estimate of the real fall. The best intervention measures — fx settlement, the PBOC balance sheet data — aren’t out for August. Those indicators suggest modest sales in July, and the change in headline reserves points to similar sales in August.

That should be expected. China’s currency depreciated a bit against the dollar late in August. In my view, the market for the renminbi is still fundamentally a bet on where China’s policy makers want the renminbi to go, so any depreciation (still) tends to generate outflows and the need to intervene to keep the pace of depreciation measured.* Foreign exchange sales are thus correlated with depreciation.

But the scale of the reserve fall right now doesn’t suggest any pressure that China cannot manage.

That is one reason why the market has remained calm.

Indeed the picture in the rest of Asia could not be more different than last August, or in January.

The won for example sold off last August and last January. More than (even) Korea wanted. During the periods of most intense stress on China, the Koreans sold reserves to keep the won from weakening further.

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What To Do When Countries With Fiscal Space Won’t Use It?

by Brad Setser

This isn’t another post about Germany.

Rather it is about Korea, in many ways the Germany of East Asia.

Korea has a current account surplus roughly equal to Germany’s—just below 8 percent in 2015, versus just over 8 percent for Germany.

Like Germany, Korea has a tight fiscal policy. Korea retained a structural fiscal surplus throughout the global crisis (it relied on exports to drive its initial recovery, thanks to the won’s large depreciation in the crisis).* After sliding just a bit between 2012 and 2015, Korea’s fiscal surplus is now heading up again.

Korea’s public debt is below that of Germany.

And as I noted on Monday, Korea’s real exchange rate is well below its pre-crisis levels. So for that matter is Germany’s real exchange ate. According to the BIS, Korea’s real exchange rate so far this year is about 15 percent below its 2005-2007 average; Germany’s real effective exchange rate is about 10 percent below its 2005-2007 average.

The IMF—in its newly published staff report on Korea—recognizes that Korea has fiscal space, and encourages the Koreans to do a bit of stimulus. The IMF also, smartly, recommends beefing up Korea’s rather stingy social safety net.

The Koreans though do not seem all that interested in spending more.

Yes, there is officially a stimulus. But as the Fund notes it will be funded by “revenue over-performance”* rather than any new borrowing.**

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$3.2 Trillion (Actually a Bit More) Isn’t Enough? The Fund on China’s Reserves

by Brad Setser

China is running a persistent current account surplus, one that could be larger than officially reported (the huge tourism deficit looks a bit suspicious).

If China paid off all its external debt, it would still have around $2 trillion in reserves.* If it paid off all its short-term debt, it would have $2.5 trillion in reserves.

And China has a very low level of domestic liability dollarization (3 percent of total deposits are in foreign currency)

True, $3.2 trillion ($3.3 trillion if you include the PBOC’s other foreign assets, as you should, and as much as $3.5 trillion if you include the China Investment Corporation’s foreign portfolio, which is more debatable) isn’t $4 trillion.**

But much of the fall in reserves over the last 18 months has stemmed from the use of reserves to repay China’s short-term external debt. The IMF projects that China’s short-term external debt will have fallen from $1.3 trillion in 2014 to just over $700 billion by the end of this year.

Reserves are down, but—from an external standpoint—China’s need for reserves is also down. The two year fall in short-term debt is actually about equal to projected drop in reserves.

The Fund though sees things a bit differently. Buffers, according to the Fund’s staff report, are now low, and need to be rebuilt. Some in the market agree.

And that gets at a critical issue for China, and a critical issue for assessing reserve adequacy more generally. Just how many reserves do countries like China, need?

For China, two “traditional” indicators of reserve adequacy—reserves to short-term debt and reserves to broad money—point in completely different directions.

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Fiscal Stimulus, Korean Style

by Brad Setser

Korea is one country that unambiguously has fiscal space right now. Low government debt. The on-budget deficit was, until recently, more than offset by the off-budget surplus in Korea’s social security fund. With a slowing economy and a massive (almost 8 percent of GDP in 2015) current account surplus, Korea unambiguously should be running an expansionary fiscal policy. Read Summers and Eggertsson.

But I do not quite see how “paying down debt” can be part of a true fiscal stimulus package.

Nor do I see how a fiscal stimulus can do much to spur the economy if it doesn’t create a new borrowing need. The Wall Street Journal:

“Unlike the heavily debt-funded supplementary budget last year, this year’s supplement will narrow the estimated deficit marginally, thanks to a partial debt repayment by the government. The finance ministry expects the country’s sovereign debt to stand at 39.3% of gross domestic product in 2016, lower than its initial estimate of 40.1%”

Emphasis added.

It seems like Korea’s stimulus will be financed by “surplus” tax revenues, not new debt.

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How Many Reserves Does Turkey Need? Some Thoughts on the IMF’s Reserve Metric

by Brad Setser

Turkey has long ranked at the top of most lists of financially vulnerable emerging economies, at least lists based on conventional vulnerability measures. Thanks to its combination of a large current account deficit and modest foreign exchange reserves, Turkey has many of the vulnerabilities that gave rise to 1990s-style emerging market crises. Turkey’s external funding need—counting external debts that need to be rolled over—is about 25 percent of GDP, largely because Turkey’s banks have a sizable stock of short-term external debt.

At the same time, these vulnerabilities are not new. Turkey has long reminded us that underlying vulnerability doesn’t equal a crisis. For whatever reason, the short-term external debts of Turkey’s banks have tended to be rolled over during times of stress.*

And, fortunately, those vulnerabilities have even come down just a bit over the last year or so. After the taper tantrum, Turkey’s banks even have been able to term out some of their external funding by issuing bonds to a yield-starved world in 2014, and by shifting toward slightly longer-term cross-border bank lending in 2015 and 2016 (See figure 4 on pg. 35 of the IMF’s April 2016 Article IV Consultation with Turkey) And while the recent fall in Turkey’s tourism revenue doesn’t look good, Turkey also is a large oil and gas importer. Its external deficit looks significantly better now than it did when oil was above a hundred and Russian gas was more expensive.

external-borrowing-vs-fx-reserves

Turkey doesn’t have many obvious fiscal vulnerabilities; public debt is only about 30 percent of GDP. Its vulnerabilities come from the foreign currency borrowing of its banks and firms.

There is one more strange thing about Turkey. Its banks have increased their borrowing from abroad in foreign currency after the global financial crisis, but there hasn’t been comparable growth in domestic foreign currency lending. Rather, the rapid growth has come in lending in Turkish lira, especially to households.

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The Outsized Impact of the Fall in Commodity Prices on Global Trade

by Brad Setser

Global trade has not grown since the start of 2015.

Emerging market imports appear to be running somewhat below their 2014 levels.

Creeping protectionism? Perhaps.

But for now the underlying national data points to much more prosaic explanation.

The “turning” point in trade came just after oil prices fell.

And sharp falls in commodity prices in turn radically reduced the export revenues of many commodity-exporting emerging economies. For many, a fall in export revenue meant a fall in their ability to pay for imports (and fairly significant recessions). For the oil exporters obviously, but also for iron exporters like Brazil.

Consider a plot of real imports of six major world economies: Brazil, China, India, Russia, the eurozone and the United States, indexed to 2012. The underlying data isn’t totally comparable. I used seasonally adjusted real goods and services imports from the National Income and Product Accounts (NIPA) data for Brazil, India, Russia and the eurozone. For China I used an index of import volumes, and smoothed it by taking a four quarter average (necessary, alas as the seasonality overwhelms the trend, even though it doesn’t make the data for China fully comparable with the data for the others countries). And for the United States I wanted to take out oil imports, and the easiest way to do that is to look at real non-petrol goods imports.

Import Vols

I see five things in this data:

(1) The 20-30 percent fall in Brazilian and Russian imports from their 2012 levels, which rather obviously is mostly tied to changes in their terms of trade. Brazil and Russia are fairly large economies, and these are giant falls.

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Hard to Pay for Imports Without Exports (BRICS Trade Contraction)

by Brad Setser

Over the past twenty years, the biggest shocks to the global economy have come from sharp swings in financial flows: Asia; the subprime crisis and the run out of shadow banks in the United States and Europe; and the euro area crisis. All forced dramatic changes in trade flows. Emerging Asia went from running a deficit to a surplus back in 1997. The global crisis led to a significant fall in the U.S. external deficit. The euro area crisis led to the disappearance of current account deficits in the euro area’s periphery. And one risk from Brexit is that it would cause funding for the U.K.’s current account deficit to dry up, and force upfront adjustment.

The biggest shock to the global economy right now though has come not from last summer’s surge in private capital outflows from China, large as the swing has been,* but rather from an old fashioned terms-of-trade shock. Oil, iron, and copper prices all fell significantly between late 2014 and today. Yes, oil has rebounded from $30, but $50 is not $100 plus.

$50 versus $100 oil means the oil-exporters collectively have something like $750 billion-a-year less to spend—either on financial assets, or on imports—than they did a couple of years ago. Add in natural gas and there has been another $100 billion plus fall in export income for the main oil-exporting economies. The fall in traded iron ore prices has had a big impact on Brazil and Australia, but in absolute terms oil’s impact dwarfs that of iron. Brazilian and Australian iron receipts in the balance of payments are down a total of $30 to $40 billion. Big, but not the huge impact of oil.

And the old fashioned terms-of-trade shock has had a much bigger global impact than I suspect is commonly realized. Consider a plot of non-oil imports of the “BRICS” (the world’s large emerging economies).

Non-Petrol Imports

The dips in Brazil and Russia in particular are crisis-like. 2015 imports—excluding oil—are down 20 to 30 percent in Brazil and Russia. And both Brazil and Russia are significant economies. A few years back, when their currencies were stronger, their economies were in the $2 to $3 trillion range—only a bit smaller than the British economy.

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A Bit More on Chinese, Belgian and Saudi Custodial Holdings

by Brad Setser

Marc Chandler asked why I chose to attribute Belgium’s holdings to China rather than any of the other potential candidates—notably the Gulf and Russia.

The answer for Russia is pretty straightforward. Russia’s holdings of Treasuries (and in the past Russia’s holdings of both Treasuries and Agencies) tend to show up in the U.S. custodial data. Russia holds around $275 billion in securities in its reserves, and it holds a relatively low share of its reserves in dollars (40 percent still?). $85 billion in Treasuries (in March) is more or less in line with expectations. There are maybe a few billion missing, but there also is no need to search for large quantities of missing Russian dollar-denominated reserve assets.

Differentiating between the Gulf and China is a bit harder. Both are to a degree “missing” in the custodial data. Both China’s and the Gulf’s custodial holdings are a bit lower than would be expected based on the size of their reserves, and for the Gulf, the size of their reserves and sovereign fund. Both are big players, so both could conceivably account for one of the key features of Belgium: the rapid rise and then the rapid fall in Belgian’s custodial holdings.

So why China?

Consider a plot of Saudi Reserves—looking only at the Saudi Arabian Monetary Agency’s (SAMA) holdings of securities. I also plotted the change that would be expected if say 75 percent of SAMA’s securities were in dollars, just as a reminder that the full change is the upper limit. SAMA also has a lot of deposits, but they aren’t relevant here.

Saudi Arabia

It is fairly clear that the changes in Belgium’s custodial holdings are a loose fit at best for SAMA’s security holdings. The big run-up in the Belgian account actually came when the pace of Saudi reserve growth was slowing. And the drawdown in Saudi reserves started a bit before the drawdown in Belgium, and has been more steady.

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Dan Drezner Asked Three Questions

by Brad Setser

He gets three half answers.

Drezner’s first question: “Just how much third-party holdings of U.S. debt does Saudi Arabia have?”

Wish I knew. The custodial data doesn’t really help us out much. $117 billion—around 20 percent of reserves—certainly seems too low. So it is likely that the ultimate beneficiaries of some of the Treasuries custodied in places like London, Luxembourg or even Switzerland (Swiss holdings are bit higher than can be explained by the Swiss National Bank’s large reserves) are in Saudi Arabia or elsewhere in the Gulf.

Europe Custodial Holdings

The Saudi Arabian Monetary Agency (SAMA) is generally thought to be a bit of a hybrid between a pure central bank reserve manager (which invests mostly in liquid assets, typically government bonds) and a sovereign wealth fund (which invests in a broader range of assets, including illiquid assets). So there is no reason to think that all of SAMA’s assets are in Treasuries.

There are a couple of benchmarks though that might help.

If you sum the Treasury holdings of China and Belgium in the Treasury International Capital (TIC) data (Belgium is pretty clearly China, not the Gulf) and compare that total with China’s reserves, Treasuries now look to be around 40 percent of China’s total reserves. Other countries have moved back into agencies, so Treasury holdings aren’t a pure proxy for a country’s holdings of liquid dollar bonds. But this still set out a benchmark of sorts.

And if you look at the IMF’s global reserves data (sadly less useful than it once was, as the data for emerging economies is no longer broken out separately), central banks globally hold about 65 percent of their reserves in dollars. This also sets out a benchmark. Countries that manage their currencies tightly against the dollar would normally be expected to hold a higher share of their reserves in dollars than the global average, though this imperative dissipates a bit when a country’s reserves far exceeds its short-term needs.

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