Using Trade to Grow: Using Trade to Grow: International Lessons (and Questions) International Lessons (and Questions)

about Exchange Rate Policy for Rwandaabout Exchange Rate Policy for Rwanda

Richard NewfarmerRichard Newfarmer

International Growth CentreInternational Growth Centre

November 1, 2010November 1, 2010

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

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 export…but 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.

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Main points…Main points…

Contribution to GDP growthContribution to GDP growth

ImportsImports

Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscriptSource: Rwanda Statistical Yearbook and World Bank, unpublished manuscript

Investment and rising consumption have been major drivers Investment and rising consumption have been major drivers of recent growthof recent growth

…….and development assistance has financed a large .and development assistance has financed a large portion of investment…portion of investment…

Source: World Bank, World Development Indicators. HP=16

… … reflected in an expansion of services and, within reflected in an expansion of services and, within industry, constructionindustry, construction

Composition of GDP Rw$T 2006 pricesComposition of GDP Rw$T 2006 prices Contribution to GDP growthContribution to GDP growth

ServicesServices

IndustryIndustry

AgricultureAgriculture

Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscriptNote: The adjustment has been equally divided and incorporated among the three sectors

AgricultureAgriculture

IndustryIndustry

ServicesServices

… … reflected in an expansion of services and other reflected in an expansion of services and other nontradables (with implications for the real exchange rate)nontradables (with implications for the real exchange rate)

Composition of GDP Rw$T 2006 pricesComposition of GDP Rw$T 2006 prices Contribution to GDP growthContribution to GDP growth

ServicesServices

IndustryIndustry

AgricultureAgriculture

Source: Rwanda Statistical Yearbook and World Bank, unpublished manuscriptNote: The adjustment has been equally divided and incorporated among the three sectors

AgricultureAgriculture

IndustryIndustry

ServicesServices

But development assistance will eventually wind down..and before that Rwanda has to look for new sources of growth. Trade is one.

The EAC countries still have much to gain with trade The EAC countries still have much to gain with trade integration – trade is below the predicted levelintegration – trade is below the predicted level

Rwanda trades less in goods than most other countries… Rwanda trades less in goods than most other countries… so trade provides an opportunity for growthso trade provides an opportunity for growth

Source: World Bank, World Development Indicators. Average 2007-2008 values. Landlocked represents the average value across landlocked developing countries excluding Rwanda.

Trade as a share of GDP, av. 2007-2008Trade as a share of GDP, av. 2007-2008

High performing countries were the fastest-growing in real GDP 1980-2006, and include Botswana, Burkina 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, Faso, Cambodia, Chile, China, India, Indonesia, Korea, Malaysia, Mauritius, Pakistan, Singapore, Sri-Lanka, Chinese Tapei, Thailand, and Uganda. Chinese Tapei, Thailand, and Uganda.

Qualifications: Services trade is not shown Qualifications: Services trade is not shown Informal trade is unrecorded… and Informal trade is unrecorded… and

investing in better data is a investing in better data is a prioritypriority

While most fast-growing economies have trade While most fast-growing economies have trade elasticities over 1.5, Rwanda’s is low even by African elasticities over 1.5, Rwanda’s is low even by African standardsstandards

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 N=25. Sub-Saharan Africa=30

Rwanda is over-reliant on a few export products…Rwanda is over-reliant on a few export products…

Source: Staff calculation based on SITC rev3 from Comtrade database

Rwanda

Source: World Bank, World Development Indicators.

……and this leads to volatility in terms of trade and and this leads to volatility in terms of trade and undermines sustained growthundermines sustained growth

Source: IGC staff calculations and WITS comtrade database

0.0

00

.25

0.5

00

.75

1.0

0

0 5 10 15analysis time

Rwanda Tanzania

Survival Probability

Exports seem to “die young” …the probability that a Exports seem to “die young” …the probability that a Rwandan export product will survive into future years is Rwandan export product will survive into future years is lower than most other countrieslower than most other countries

Rwanda

Tanzania

We ran these numbers also with Kenya and Uganda and other countries, and Rwanda has among the lowest survival rates

Scope for export Scope for export promotion efforts promotion efforts to sustain to sustain products?products?

Year 2 only 70% of Year 2 only 70% of new products remainnew products remain

From international experience, four determinants of From international experience, four determinants of success in trade beyond good investment climate…success in trade beyond good investment climate…

Infrastructure Infrastructure is a major constraint in most countriesis a major constraint in most countries

Lowering costs of tradingLowering costs of trading is essential to rapid growth is essential to rapid growth

Regional trade agreements have to be designed to promote Regional trade agreements have to be designed to promote deep integrationdeep integration… otherwise smallest members suffer … otherwise smallest members suffer

Managing the Managing the real exchange ratereal exchange rate effectively is essential to effectively is essential to maintain competitivenessmaintain competitiveness

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In each area, these lessons prompt questions that Rwandan authorities might want to address… particularly management of the exchange rate

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• First, growth accelerations – an increase in GDP growth rate of 2%+ per First, growth accelerations – an increase in GDP growth rate of 2%+ per annum and sustained for 8 years -- are quite frequent. …more than 80 annum and sustained for 8 years -- are quite frequent. …more than 80 episodes since 1950 of rapid acceleration in economic growth that are episodes since 1950 of rapid acceleration in economic growth that are sustained for at least eight years. sustained for at least eight years.

• Second, growth accelerations tend to be correlated with Second, growth accelerations tend to be correlated with increases in increases in investmentinvestment and and tradetrade, and with , and with real exchange rate depreciationsreal exchange rate depreciations. .

• Third, political-regime changes are predictors of growth accelerations. Third, political-regime changes are predictors of growth accelerations.

• Fourth, other determinants determine whether the acceleration is sustained Fourth, other determinants determine whether the acceleration is sustained into the longer term or not. External shocks tend to produce growth into the longer term or not. External shocks tend to produce growth accelerations that eventually fizzle out, while economic reform is a accelerations that eventually fizzle out, while economic reform is a statistically significant predictor of growth accelerations that are sustained. statistically significant predictor of growth accelerations that are sustained.

• Finally, growth accelerations tend to be highly unpredictable: the vast Finally, growth accelerations tend to be highly unpredictable: the vast majority of growth accelerations are unrelated to standard determinants majority of growth accelerations are unrelated to standard determinants such as political change and economic reform, and most instances of such as political change and economic reform, and most instances of economic reform do not produce growth accelerations.economic reform do not produce growth accelerations.

Haussman, et al (2004): Five findings about Haussman, et al (2004): Five findings about “growth accelerations”“growth accelerations”

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Management of the real exchange rate: Important to Management of the real exchange rate: Important to facilitate export drivesfacilitate export drives

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Impact of 50% Real Undervaluation on GDP per Capita Growth

Impact of 50% Real Undervaluation on Exports to GDP Ratio

Source: Haddad, 2010

Successful export drives have maintained a competitive Successful export drives have maintained a competitive real exchange rate… real exchange rate…

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China: Level of Real Exchange Rate, 1992-2007

(Up = real depreciation)

China is one example of using a competitive real China is one example of using a competitive real exchange rate to export and grow…(perhaps to excess) exchange rate to export and grow…(perhaps to excess)

Source: Eichengreen, 2008

1919Source: Eichengreen, 2008

Volatility (= the absolute value of the percentage change of the real effective exchange rate of the preceding years)

……and exchange rate volatility is negatively associated and exchange rate volatility is negatively associated with GDP p.c. growth… with GDP p.c. growth…

2020

……is there room for a better alignment between monetary is there room for a better alignment between monetary and trade –growth objectives? and trade –growth objectives?

……Rwanda may wish to undertake its own analysisRwanda may wish to undertake its own analysis

Global “currency wars” make watching the exchange rate Global “currency wars” make watching the exchange rate more important: real exchange rates have shifted more important: real exchange rates have shifted competitiveness since the onset of the Great Recessioncompetitiveness since the onset of the Great Recession

Source: J.P. Morgan, October 21, 2010

……and Rwanda may wish to track these developments to anticipate and Rwanda may wish to track these developments to anticipate external exchange rate surprises external exchange rate surprises

Rwanda’s 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.

2222

Conclusions…Conclusions…

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The IGC Program in Tanzania: Towards Monetary IntegrationJoint research plan for monetary union developed by Monetary Affairs Committee Joint research plan for monetary union developed by Monetary Affairs Committee of the East African Community. Bank of Tanzania / IGC-T lead agency on:of the East African Community. Bank of Tanzania / IGC-T lead agency on:

––Exchange rate regimes and convergence Exchange rate regimes and convergence ––Monetary transmission mechanism Monetary transmission mechanism ––Money demand Money demand

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

The IGC would be pleased to sponsor a greater The IGC would be pleased to sponsor a greater participation of BNR in this researchparticipation of BNR in this research

References citedReferences cited

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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

Using Trade to Grow: Using Trade to Grow: International Lessons (and Questions) International Lessons (and Questions)

about Exchange Rate Policy for Rwandaabout Exchange Rate Policy for Rwanda

Richard NewfarmerRichard Newfarmer

International Growth CentreInternational Growth Centre

November 1, 2010November 1, 2010

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