Using Trade to Grow: International Lessons (and Questions) about Exchange Rate Policy for Rwanda

1
Using Trade to Grow International Lessons (and
Questions) about Exchange Rate Policy for Rwanda

• Richard Newfarmer
• International Growth Centre
• November 1, 2010

This presentation benefitted from research of
Laura Collinson, Economist IGC -Rwanda
2
Main points
Rwanda has used donor finance wisely to build
its much need infrastructure, and this has been a
driver of growth but over the long run Rwanda
has to look for additional sources of growth.
One potential growth source is exportbut to
date trade remains an under-exploited opportunity
for Rwanda trade ratios for goods are low,
diversification across products and geographic
markets is low, and new exports seem to die
quickly International experience raises
questions in several areas that might merit
additional policy discussion (e.g.,
infrastructure, reducing trading costs,
leveraging regional trade agreements) but one of
the most important is management of real exchange
rate.
3
Investment and rising consumption have been major
drivers of recent growth

• Contribution to GDP growth

Imports
Source Rwanda Statistical Yearbook and World
Bank, unpublished manuscript
4
.and development assistance has financed a large
portion of investment
Source World Bank, World Development Indicators.
HP16
5
reflected in an expansion of services and,
within industry, construction

• Composition of GDP RwT 2006 prices

• Contribution to GDP growth

Services
Services
Industry
Industry
Agriculture
Agriculture
Source Rwanda Statistical Yearbook and World
Bank, unpublished manuscript Note The adjustment
has been equally divided and incorporated among
the three sectors
6
reflected in an expansion of services and other
nontradables (with implications for the real
exchange rate)

• Composition of GDP RwT 2006 prices

• Contribution to GDP growth

Services
Services
Industry
Industry
Agriculture
Agriculture
But development assistance will eventually wind
down..and before that Rwanda has to look for new
sources of growth. Trade is one.
Source Rwanda Statistical Yearbook and World
Bank, unpublished manuscript Note The adjustment
has been equally divided and incorporated among
the three sectors
7
The EAC countries still have much to gain with
trade integration trade is below the predicted
level
8
Rwanda trades less in goods than most other
countries so trade provides an opportunity for
growth
Trade as a share of GDP, av. 2007-2008
Qualifications Services trade is not shown
Informal trade is unrecorded and
investing in better data
is a priority
High performing countries were the
fastest-growing in real GDP 1980-2006, and
include Botswana, Burkina Faso, Cambodia, Chile,
China, India, Indonesia, Korea, Malaysia,
Mauritius, Pakistan, Singapore, Sri-Lanka,
Chinese Tapei, Thailand, and Uganda.
Source World Bank, World Development Indicators.
Average 2007-2008 values. Landlocked represents
the average value across landlocked developing
countries excluding Rwanda.
9
While most fast-growing economies have trade
elasticities over 1.5, Rwandas is low even by
African standards
Source Staff calculations and World Bank, WDI.
Note considering countries with data for the
entire time series. The category landlocked
developing countries excluded Rwanda and N25.
Sub-Saharan Africa30
10
Rwanda is over-reliant on a few export products
Source Staff calculation based on SITC rev3 from
Comtrade database
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and this leads to volatility in terms of trade
and undermines sustained growth
Rwanda
Source World Bank, World Development Indicators.

12
Exports seem to die young the probability
that a Rwandan export product will survive into
future years is lower than most other countries
Year 2 only 70 of new products remain
Tanzania
Scope for export promotion efforts to sustain
products?
Rwanda
We ran these numbers also with Kenya and Uganda
and other countries, and Rwanda has among the
lowest survival rates
Source IGC staff calculations and WITS comtrade
database
13
Rwanda products seem to exit the foreign market
more frequently
Source Staff calculations and WITS comtrade
database
14
From international experience, four determinants
of success in trade beyond good investment
climate

• Infrastructure is a major constraint in most
  countries
• Lowering costs of trading is essential to rapid
  growth
• Regional trade agreements have to be designed to
  promote deep integration otherwise smallest
  members suffer
• Managing the real exchange rate effectively is
  essential to maintain competitiveness

In each area, these lessons prompt questions that
Rwandan authorities might want to address
particularly management of the exchange rate
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Haussman, et al (2004) Five findings about
growth accelerations

• First, growth accelerations an increase in GDP
  growth rate of 2 per annum and sustained for 8
  years -- are quite frequent. more than 80
  episodes since 1950 of rapid acceleration in
  economic growth that are sustained for at least
  eight years.
• Second, growth accelerations tend to be
  correlated with increases in investment and
  trade, and with real exchange rate depreciations.
  
• Third, political-regime changes are predictors of
  growth accelerations.
• Fourth, other determinants determine whether the
  acceleration is sustained into the longer term or
  not. External shocks tend to produce growth
  accelerations that eventually fizzle out, while
  economic reform is a statistically significant
  predictor of growth accelerations that are
  sustained.
• Finally, growth accelerations tend to be highly
  unpredictable the vast majority of growth
  accelerations are unrelated to standard
  determinants such as political change and
  economic reform, and most instances of economic
  reform do not produce growth accelerations.

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Management of the real exchange rate Important
to facilitate export drives

• Avoiding overvaluation Early success at
  exporting (or mobilizing donor finance) can drive
  up currency value and raise price of exports.
• Aghion (2006) overvaluation leads to slow
  productivity growth
• Maintain competitiveness Competitive exchange
  rate may foster growth learning by doing
  associated with productive activities for exports
  
• Hausmann, et al (2004) 80 growth
  accelerations of 2 points 8 years real
  devaluation was signifcant predictor
• Country experiences Korea (1964-mid-1970s),
  Chile 1982-92, China post -1994
• Conclusion Answer is not obvious, not easy and
  not cost-less Appropriate policy mix depends on
  objectives and situation REER targeting
  difficult increasing reserves can be costly
• Eichengreen, 2008 The real exchange rate is
  best thought of as a facilitating condition
  keeping it at competitive levels and avoiding
  excessive volatility facilitates efforts to
  capitalize on these fundamentals (that is,
  education, savings, investment and institutional
  capacity to assimilate technology)

17
Successful export drives have maintained a
competitive real exchange rate
Impact of 50 Real Undervaluation on GDP per
Capita Growth
Impact of 50 Real Undervaluation on Exports to
GDP Ratio
Source Haddad, 2010
18
China is one example of using a competitive real
exchange rate to export and grow(perhaps to
excess)
China Level of Real Exchange Rate, 1992-2007
(Up real depreciation)
Source Eichengreen, 2008
19
and exchange rate volatility is negatively
associated with GDP p.c. growth
Volatility ( the absolute value of the
percentage change of the real effective exchange
rate of the preceding years)
Source Eichengreen, 2008
20
is there room for a better alignment between
monetary and trade growth objectives?
Rwanda may wish to undertake its own analysis
21
Global currency wars make watching the exchange
rate more important real exchange rates have
shifted competitiveness since the onset of the
Great Recession
and Rwanda may wish to track these developments
to anticipate external exchange rate surprises
Source J.P. Morgan, October 21, 2010
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Conclusions
Rwandas objective of using trade to power
growth is well-formulated and the government
has identified all the right issues from
infrastructure to trading costs to regional
integration. But price incentives will
determine success or failure of any export drive
and arguably the most important price in the
economy is the rate of foreign exchange. Hence
understanding the recent historical role of
exchange rate determination and exploring ways
the government might maintain a competitive real
effective exchange rate especially in light of
a prospective EAC monetary union -- is crucial.
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The IGC Program in Tanzania Towards Monetary
Integration
Joint research plan for monetary union developed
by Monetary Affairs Committee of the East African
Community. Bank of Tanzania / IGC-T lead agency
on Exchange rate regimes and convergence
Monetary transmission mechanism Money demand

• Money and Monetary Policy Issues
• BoT--along with rest of EAC targets inflation
  using a monetary anchor (M2), with reserve money
  as the operational target but RM programs might
  be losing effectiveness
• Research Papers
• Money demand complete on line
• Liquidity management and the money multiplier
  complete final review
• Dollarization and currency substitution complete
  final review
• Food prices and the dynamics of inflation in
  Tanzania in progress
• Financial architecture and the monetary
  transmission mechanism 2010 Q4

The IGC would be pleased to sponsor a greater
participation of BNR in this research
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References cited
Aghion, Philippe, Philippe Bacchetta, Romain
Ranciere and Kenneth Rogoff, 2006. Exchange Rate
Volatility and Productivity Growth The Role of
Financial Development. NBER Working Paper No.
12117. Eichengreen, Barry, 2008. The Real
Exchange Rate and Economic Growth. Commission on
Growth and Development. World Bank Washington,
DC Haddad M., and C. Pancaro, 2010. Can Real
Exchange Rate Undervaluation Boost Exports and
Growth in Developing Countries? Yes, But Not for
Long. Economic Premise No. 20. World Bank,
Washington, DC International Monetary Fund (IMF),
2010. Rwanda Request for a Three-Year Policy
Support Instrument. IMF Washington DC Hausmann,
Ricardo, Lant Pritchett, and Dani Rodrik, 2004.
Growth Accelerations. NBER Working Paper No.
W10566. Levy Yetati, Federico Sturzenegger
Eduardo and I. Reggio, 2003. On the Endogeneity
of Exchange Rate Regimes. Unpublished manuscript,
Universidad di Tella. Spence, Michael. 2008. The
Growth Report Strategies for Sustained Growth
and Inclusive Development. Commission on Growth
and Development. World Bank Washington,
DC Winters, L. Alan, 2004. Trade Liberalization
and Economic Performance An Overview. The
Economic Journal, 114 (February) Oxford
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Using Trade to Grow International Lessons (and
Questions) about Exchange Rate Policy for Rwanda

• Richard Newfarmer
• International Growth Centre
• November 1, 2010

This presentation benefitted from research of
Laura Collinson, Economist IGC -Rwanda