A meeting of finance ministers from the G20 in Moscow at the weekend sought to ease fears that the biggest economies have launched in a race to the bottom to devalue their currenciesto boost exports.
"We reiterate that excess volatility of financial flows and disorderly movements in exchange rates have adverse implications for economic and financial stability,” a press release at the end of the meeting stated.
"We will not target our exchange rates for competitive purposes. We will resist all forms of protectionism and keep our markets open."
Officials in emerging markets, and especially in Latin America, have repeatedly complained about extra-loose monetary policy in developed countries that pushes inflows of capital into emerging economies in search for yield, putting pressure on their currencies to appreciate.
But “capital inflows into emerging economies are not only of the portfolio form; foreign direct investment (FDI) has been pouring into several emerging markets,” Claudio Irigoyen, an analyst with Bankof America Merrill Lynch, wrote in a market note.
“As long as these FDI inflows increase the productivity of capital and labour, recipient economies’ equilibrium exchange rates rise as well.”
Loose monetary policy in developed countries is also associated with higher commodity prices, which helps emerging economies that are rich in natural resources, he added.
“A real exchange rate appreciation in emerging markets is then necessary to accommodate stronger terms of trade,” Irigoyen added.
NO LIQUIDITY TRAP
None of the economies of Latin America is in a liquidity trap – when central bank stimulus is unable to boost the economy – as average economic growth and average inflation have been above 3% in 5 of the biggest open economies (Brazil, Mexico, Colombia, Chile and Peru) over the past 3 years, he said.
Brazil has the worst mix of growth to inflation, with an average growth rate of 3.7% and average inflation of 5.8%, he noted. The currencies of all 5 countries have appreciated in real terms since 2010, but this has been in line with improving terms of trade for all except Peru, Irigoyen also said.
“LatAm economies have strong enough fundamentals to sustain currency appreciation, in our view,” he said.
“Mexico, where currency war rhetoric is mostly absent, has particularly strong fundamentals. We do not expect intervention in the near term and we anticipate the MXN to outperform the rest of LatAm FX.”
Colombia and Peru are already intervening and Chile “may be close to” doing the same thing, according to Irigoyen.
But Brazil is in a different situation, with growth below that of its peers and inflation well above.
“And since retail sales and the labour market are strong, there is not much monetary policy can do,” Irigoyen said.
He added that while most of the G10 economies are in a liquidity trap with low growth, emerging economies are not, and their currencies will rise in real terms, either via nominal appreciation or via higher inflation.
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