IMF "Emerging Market Currency Depreciation → Export Increase → Economic Recovery? Difficult Due to Dollar"

[Image source=AP Yonhap News]

[Asia Economy Reporter Jeong Hyunjin] On the 20th (local time), the International Monetary Fund (IMF) released an analysis stating that emerging and developing countries experiencing currency depreciation due to the spread of the novel coronavirus infection (COVID-19) are unlikely to expect economic recovery through export expansion. This means that the dominance of the dollar in the global trade market prevents an increase in export demand due to exchange rate fluctuations, ultimately suggesting that the dollar could amplify the shock of the pandemic.

In a blog post titled "Dominant Currencies and Limits to Exchange Rate Flexibility" published on the same day, the IMF stated, "There is increasing evidence that most global trade invoices are denominated in a few currencies, especially the US dollar." The IMF explained that the share of dollar transactions is high beyond the trade volume with the United States, and this phenomenon occurs more frequently in emerging and developing countries.

Within this structure, during the COVID-19 crisis, funds flowed into the safe-haven dollar, and foreign capital fled from emerging countries, causing significant depreciation of currencies in emerging and developing countries. This situation might raise expectations that exchange rate effects could increase exports in emerging countries, potentially helping to relatively recover their already struggling economies.

Regarding this, the IMF analyzed that under the traditional view, where domestic companies set prices for goods and services based on their own currency, "when export prices are set in dollars or euros, a depreciation of the domestic currency does not make goods or services cheaper enough to incentivize foreign buyers to increase demand." This means that because the dollar dominates trade and companies set product prices initially in dollars or other dominant currencies, exchange rate changes have little impact.

For this reason, the IMF explained that while currency depreciation in emerging and developing countries used to act as a "shock absorber" by increasing exports and mitigating economic damage during negative economic crises, the expansion of dollar dominance has changed this dynamic.

Additionally, the IMF pointed out, "When the value of the domestic currency weakens against the dollar, the price of imports converted into domestic currency rises, reducing demand for imported goods." Furthermore, it analyzed that import companies may face difficulties in securing funds due to increased debt burdens and concerns over deteriorating repayment capacity.

The report was authored by Chief Economist Gita Gopinath, Senior Economist Gustav Adler, and Economist Carolina Osorio Buitron, who stated, "The dominance of the dollar in trade and finance can amplify the damage caused by the COVID-19 crisis." They emphasized that "the global strength of the US dollar, considered a safe-haven asset, is likely to deepen the economic downturn in global trade and economic activity in the short term," and stressed the need for monetary and fiscal policies that can support the economies of emerging and developing countries in the short term.