The last financial crisis and its lingering global effects have reinforced the idea that all governments must be ready to deal with the next financial crisis. This is particularly true of emerging economies. Many developing nations have adopted various forms of foreign exchange policies in an attempt to have some control of the value of their own currencies. Presumably, this would give them some room to promote their exports and to foster some degree of economic and financial stability to attract foreign and domestic productive, as opposed to speculative, job-creating investment; ultimately creating stable jobs with good salaries for the large majority of the labor force. In my research I explore the long-term sustainability of these types of policies.
Policy sustainability is important because to transform a social system public policy needs a chance to work. The problem is that in many of these countries these policies are applied for periods of time that are not long enough to promote a long term change to their social system; an structural change. Therefore, to study the channels through which policy becomes fragile or vulnerable is to explore policy sustainability and ultimately the chance a given emerging country has of improving its social system.
Foreign exchange interventions, in combination with a set of social policies, could be used by emerging countries to improve the lives of the large majority of people. However, exchange rate policies do come with a price tag. Promoting exports is a desirable outcome benefiting exporters and capitalists and workers along the supply chain. However, when large producers bring their revenues home the Central Bank needs to intervene to support its policy. This forces the Central Bank to issue bonds with attached interest to it. And this becomes an important channel of fragility.
The interest that an emerging country has to pay when issuing a bond, like the ones needed to operationalize the export promoting policy, is affected by the country risk index. If the country becomes more risky the bond must offer a greater interest rate to attract buyers. The problem is that the country risk index is affected by many variables, like political and social instability, expectations, macroeconomic fundamentals, and reports from rating agencies, for example. The greater the risk the less money the government will have in the future to fund social programs to improve the lives of people, the less happy people will be, in particular vulnerable sectors, and the more likely they will complain against these policies. The problem is very complex because many of the channels leading to policies fragilities are embedded in the realm of social and political analysis naturally calling for a multidisciplinary approach.
The Argentine Experience
A country like Argentina, for example, provides a fertile soil to explore some of these issues. The government has been administering its exchange rate to promote the country’s exports and has been forced to increase the interest rates on its bonds as more bonds were issued on different occasions. This has a significant impact on fiscal policy. The role played by Argentina’s country risk index has been important. Many times the index has jumped up above the average of other countries similar to Argentina. Many explanations have been offered to account for that level of volatility. But most of the studies approach the exploration with statistical estimations, regressions, using panel data for a number of countries and a number of years. Those studies are useful and interesting, but they suggest results that may hold in the long run and for the average country. However, they may not provide guidance at the country level, which is what a policymaker may need to estimate the potential costs of policies.
On the other hand, I explore the day-to-day determinants of Argentina’s country risk index. However, I am doing it for a short period of time during 2008 and 2009 when its index jumped unusually above the average for the group of emerging economies and stayed up for a while, hovering like a helicopter before gradually descending back to the average. The day-to day examination may not yield generalizable results, but these, however, should be of interest to policymakers and other researchers because some of the results seem to be counterintuitive and are based on events familiar to the local socioeconomic environment.
Financial Market Behavior
For example, while econometric estimations suggest certain degree of symmetry about the effect that determinants have on risk, a day-to-day examination may suggest otherwise. This is particularly interesting for policymakers who are often told that “good behavior” will be rewarded with lower country risk. This may not be always the case. Robustness of statistical inference does not imply total certainty, but researchers tend to be enthusiastic about their results and may claim generalities based on significance. A discrete examination may suggest that this degree of optimism is a little bit overrated. For policymakers this means that engaging in more market-friendly policies may not yield the expected results.
Moreover, early results suggest that while the risk index of Argentina jumped as the consequence of few events, the index took a long time to come down. This seems to suggest that risk is very sensitive to certain triggering events but once is up it takes a while to come down even during periods of relative tranquility. Hence, market players do not seem to behave symmetrically, suggesting that human perception of risk is driven by a set of complex non-linearly related variables.
Mass Media and Ideology
The mass media could also play a role in affecting the risk index of an emerging country like Argentina. In a future paper, with a coauthor from the field of communications, I will explore how different sources of mainstream media cover the same events, for example policies where the government increases the level of market regulation, in particular the financial sector, where the government takes total or partial control of the retirement system, the national airlines, or the national oil company. Negative coverage of the media may have an effect on the country risk index.
Mass Media and Tone
Exploiting the same data, a second paper could address the tone of different media. For example, some of the dominant media tend to have conservative views of policies while the more progressive media is supportive of proactive government policies to help the working class. An examination of the coverage of content may show to what extent the media shapes the way people react to certain policies in Argentina. If a segment of the population reacts against the government because they are instigated by government-unfriendly media, this could lead to an increase in the country risk index, thereby increasing the vulnerability of the exchange rate policy and affecting its long-term sustainability.
In sum, exploring the potential channels and linkages leading to those channels by which the long-term sustainability of the export-promoting foreign exchange policy is threatened is akin to studying the reasons behind the potential failure of the macroeconomic policies employed today by many emerging economies around the world. The Argentine case is nothing but emblematic because Argentina adopted these policies since 2003 and, consequently, has experienced successes and failures. And we want to learn from them.