Exchange rate fluctuations in the corona pandemic – emerging markets under pressure

Last week, we examined how industrialized countries’ exchange rates during the corona pandemic have developed compared to the financial and economic crisis of 2008/09. In this blog post, we look at how their currencies’ exchange rate changes hurt the BRIC countries (Brazil, Russia, India, and China), as they belong to the largest and most important emerging markets.

Capital withdrawal from emerging markets

With the Corona pandemic outbreak, a substantial withdrawal of capital from many developing and emerging economies began. International investors withdrew their capital from those countries classified as unsafe and placed it in “safe havens.” In the first two months of the pandemic (between early February and early April 2020), around 100 billion US dollars were withdrawn from developing and emerging countries. Following the Lehman bankruptcy, the figure was only around US dollar 25 billion in a comparable period.

Even during the corona pandemic, flight to safe havens is an important motive for investors. The saga of the four BRIC countries’ currencies is a telling example.

Before we look at the four BRIC countries specifically, however, it is important to note that these countries have different exchange rate systems. The helps to understand these differences better:

According to the IMF, Russia is the only country among the BRIC with a free-floating exchange rate. This means that the market sets the Russian ruble rate, and “intervention occurs only exceptionally and aims to address disorderly market conditions […].”

The exchange rates of Brazil and India, however, are classified as floating. So the Brazilian real and the Indian rupee are “largely market-determined, without an ascertainable or predictable path for the rate.”

China’s exchange rate system is a bit more complex and therefore classified as an “Other managed arrangement” by the IMF. More specifically,

“China officially maintains a de jure managed floating exchange rate arrangement with a view to keeping the [renminbi] (RMB) exchange rate stable at an adaptive and equilibrium level based on market supply and demand with reference to a basket of currencies to preserve the stability of the Chinese economy and financial markets. The floating band of the RMB’s trading prices is 2% against the US dollar in the interbank foreign exchange market.”

India: Only moderate depreciation of the rupee in the Corona crisis

In the first month of each of the last 2 crises, the euro gained around 7 percent against the Indian currency. In the financial and economic crisis of 2008/09, the appreciation of the euro was still around 7 percent ten months later – i.e., at the end of June 2009. However, in the corona pandemic, appreciation in the same period was around 11 percent – much greater or more permanent.

Brazil and Russia: Currencies of oil-exporters under devaluation pressure

In Brazil, the situation played out differently. At the beginning of the 2008/09 financial and economic crisis, the euro appreciated almost 40 percent against the Brazilian real within one month. However, one year later, at the end of August 2009, the euro was only eleven percent higher than on September 1, 2008.

In the Corona pandemic, the decline in value of the Brazilian real is continuing for longer. In mid-May 2020, the appreciation of the euro against the real was around 37 percent. Following temporary declines, the value of the euro continued to rise. At the end of October 2020, the appreciation of the euro was around 45 percent.

One reason for the much more substantial decline in the Brazilian currency than the Indian rupee is the greater importance of raw material exports for Brazil. When the demand for raw materials – (above all for oil, which is one of Brazil’s most important export goods) – collapses in a severe economic crisis, Brazil’s exports suffer from both falling export prices and lower export volumes. The consequence is a sharp drop in export revenues. As a result, demand for the Brazilian currency also collapses, leading to a depreciation in the currency.

This high dependence on raw material exports also applies to Russia, which explains the decline in the Russian ruble’s value.

It is also possible that the government’s handling of the corona pandemic also influenced exchange rate developments. Like Donald Trump, Brazilian President Bolsonaro downplayed the danger of the coronavirus. As a result, measures to contain the pandemic failed to materialize, discouraging international investors.

China: The renminbi remains relatively stable during the crisis

Compared to the other BRIC countries, the value of the Chinese currency is developing much differently in the current corona pandemic than during the financial and economic crisis of 2008/09.

Between mid-September and mid-November 2008, the euro lost almost 20 percent of its value against the RMB because China pegged the value of its currency to the value of the US dollar in July 2008. The exchange rate was fixed at 6.83 RMB for one US dollar until June 2010 (page 5 and 12). Therefore, the Euro to RMB’s exchange rate development followed the exchange rate from Euro to US dollar.

In contrast, in the Corona pandemic, the euro gained against the RMB, which is now allowed to float by around 2 percent against the US dollar, albeit very moderately. Between the beginning of February 2020 and mid-March 2020, the value of a euro against the Chinese currency rose by almost 3 percent. The euro has continued to appreciate against the RMB through the end of July, gaining around 6.5 percent. Since then, the euro has lost value. At the end of November 2020, the exchange rate was back at the level of early February.

The main reason the Chinese currency recovered is that China reached the bottom of the current economic crisis in the first quarter of 2020 due to the rigid restrictions and a massive lockdown, which brought the pandemic under control. Since then, the Chinese economy has been growing strongly. By the second quarter of 2020, more than compensated for the first quarter’s GDP loss.

Why are strong exchange rate fluctuations a problem?

Exchange rate fluctuations cause uncertainty for all economic actors. From a European perspective, for example, one should think of expenditures expressed in euros for imported raw materials such as crude oil. Raw materials are invoiced in US dollars. If these expenses fluctuate due to exchange rate fluctuations, this leads to an uncertain calculation basis for companies. Expenses for imports from the USA, which must be paid in US dollars, are also uncertain.

As shown in the previous blog post, these uncertainties are less pronounced for industrialized nations during the corona pandemic because of the lower exchange rate fluctuations. This has had a positive effect on economic development. Greater exchange rate stability is an element that promotes Europe’s economic recovery.

However, for the emerging and developing economies from which capital was withdrawn, there are considerable financing problems. A vicious circle threatens here: the withdrawal of capital from countries classified as “unsafe havens” leads to devaluation, which weakens the confidence of international investors in the country concerned.

They avoid the country because they fear further devaluation, which reduces the value of their invested capital. As a result, the affected emerging and developing countries lack the financial resources they need to import vital products (e.g., medical products) and capital goods for investments. This makes it particularly difficult for emerging and developing countries to repair the Corona pandemic’s health, economic, and social damage.

To stabilize their exchange rates, emerging markets have adhered to a policy mix, as shown by an analysis of the Organisation of Economic Co-operation and Development (OECD) Brazil, Russia, and India have, for example, intervened in the foreign exchange markets, relying on their reserves to support their currencies. India and China have eased controls on capital inflows. Moreover, multilateral approaches, such as bilateral swap agreements between central banks, e.g., between the Fed and the ECB, aim to maintain foreign exchange liquidity.

However, since the pandemic is far from over and uncertainty will prevail over the next few months, close monitoring of current measures is necessary, and further adaptations might be required. International cooperation and coordination, e.g., among the G20, could play an important role in preventing negative spillovers of national measures to other countries and a more long-term destabilization of emerging market economies.