Volume 44, Number 175,
October-December 2013
Would a More Flexible Exchange
Rate Improve Competitiveness?
Guadalupe Mántey
THE EFFECTS OF DEVALUATION ON THE BALANCE SHEETS OF DEVELOPING ECONOMIES

Studying the effects of devaluation on the balance sheets of economic agents is a relatively recent field, especially in countries with high liability dollarization. This area of study is based on empirical research in two topics. First, the factors that determine the sudden stops of external financing, which led to the 1990s crises in emerging economies. Second, the intolerance to foreign debt seen in developing countries as compared to developed countries.

There are diverging explanations for the sudden stops of external financing and intolerance to foreign debt in emerging nations, but both lines of thought attribute these phenomena to high liability dollarization.

Calvo et al. (2004) has argued that the 1990s crises in emerging economies were not produced by anchoring exchange rates, but rather that economic collapse followed adjustments in the exchange rates. His research reveals that these crises were the consequence of sudden stops of external financing, which came about due to high levels of liability dollarization and leverage of current accounts in these nations.

For these authors, the proportion of imports covered by external financing is an indicator of the adjustment that a nation would need to make to its real exchange rate to recover external balance, if financial markets were to put it to the test. The expected effects on the balance sheets of economic agents as a result of the required adjustments to the real exchange rate and the high proportion of liabilities in foreign currency would contribute to the sudden stop of external financing.

Eichengreen et al. (2003), on the other hand, maintains that although inadequate policies can produce intolerance to foreign debt in any country, in emerging economies, this phenomenon is also related to the way in which international investors choose to structure their portfolios, specifically in terms of the factors that influence their country risk evaluations. These authors created a variable representative of the “original sin” of developing countries5 and found that it contributed significantly to explaining sovereign bond ratings in international markets, as well as the accumulation of international reserves and the fear of floating in emerging countries.

The magnitude of the financial effects of devaluation in countries with high liability dollarization becomes clear by relating foreign debts with their gdp.

Figure 3 relates the real exchange rate of the twelve developing countries studied with their foreign debt as a proportion of gdp, from 1995 to 2009. This figure shows that the amount of foreign debt has fallen while exchange rates have appreciated. It also reveals that since 2002, the countries included in the sample have followed a policy of gradual currency appreciation, contrary to what they have done in past years, characterized by currency crises and their contagious effects.


Figure 3. The Real Exchange Rate and the Relationship Between Foreign Debt and gdp
in Twelve Developing Countries from 1995 to 2009




Source: Prepared by the author based on data from International Financial Statistics from the International Monetary Fund.

5 This variable relates the value of securities in their own currency that a country placed abroad with the total value of securities placed abroad.

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PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 194 July-September 2018 is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
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