Is fear of floating same as fear of appreciation?

So far, it has been felt that developing countries have this fear of floating.

Emerging markets have underdeveloped financial systems and don’t have easy access to finance. Hence they borrow abroad and as a result the balance sheets are mostly dollarized. In case there is a crisis, the demand for domestic currency goes down, and it looses value. As a result,the value of liabilities increase and if currencies are allowed to float freely, the impact of crisis could be severe and hence the term “fear of floating”.

This fear came at the time of South East Asian crisis. If you note, the main fear then was depreciation of the currency.

However, what we see these days is the opposite – fear of appreciation. Most emerging markets have managed floating exchange rates and intervene in forex markets to keep their currencies undervalued. They don’t want their currencies to appreciate as it would harm their exports.

Hence we have fear to appreciate. This has been conveyed in an excellent paperby Eduardo Levy-Leyati and Federico Sturzenegger. I was actually surprised why didn’t it strike me before?

More generally, the incentives and implications to intervene in order to avoid an appreciation are radically different from those related to avoiding a depreciation: where the latter focus on short-run financial crises, the former is usually predicated on long-term economic growth. Similarly, the context conducive to one or the other differs: whereas fear of floating would tend to arise in times of financial turmoil, fear of appreciation will likely be triggered by economic bonanzas.At any rate, treating interventions in a symmetric way –in particular, attributing any intervention to fear of floating as has been previously the case in the literature– may lead to overstate the incidence of financial factors –more so in recent years when fear of appreciation appears to have prevailed.

Read the paper for further details.

It has another surprise finding.The normal belief is that undervalued currency should help exports to grow and hence aide growth. In  other words, the growth is export driven. The authors find that exports hardly contribute to the growth and the main channel of growth is that depreciated currency leads to higher savings which are channelised into investments and finally growth.

This study is worth replicating in the Indian context and see the results.