A devaluation too far

Author Ben Winkley

There’s a new economic policy game in town, and its name is devaluation.

There’s a new economic policy game in town, and its name is devaluation.

China led the way and hogged the headlines, but stands apart — its devaluation is a reflection of years of yuan strength against the US dollar, of massive debt-powered investment, of the uneven allocation of resources during this time, and of the desire to move onto a new phase of development. But the move by the People’s Bank of China sure provided food for thought in countries with managed exchange rates, and in particular for those seeing fewer dollars in return for their oil.

For oil producing nations, devaluation is becoming a useful tool of fiscal policy. Vietnam has devalued its dong not once but three times this year; and Kazakhstan’s freeing of the tenge this month could herald a wave of like-minded moves, with implications for foreign investment and domestic policy. In countries without strictly managed exchange rates, the name of the game is depreciation, but it amounts to the same thing. Brazil and Russia bit that bullet last year.

Weaker currencies should reduce the costs of doing business for overseas companies — cheaper local labour, cheaper local services, cheaper local materials, reduced operating costs and better margins. Lower costs, right now, are the industry’s Holy Grail.

This would be a boon for Mexico, for example, where a weaker peso could drag in some of the US operators that were conspicuous by their absence from the disappointing recent offshore licensing round.

By contrast, Nigeria and Angola appear to be pursuing policies that would negate the benefits of a weaker currency. Nigeria’s new president Muhammadu Buhari — as part of his wide-ranging assault on received wisdom in his country’s oil sector — has told state-owned behemoth NNPC to work more closely with domestic firms working in the upstream. The Angolan government is mulling something similar.

Is anyone immune to the temptations of devaluation? The answer to this is so uncertain that Barclays felt obliged, in recent research on the Saudi Arabian economy, to stress that it thought a devaluation of the riyal unlikely. Saudi Arabia’s currency has been devalued in the past — in the late 1950s, after the second Arab-Israeli war reduced the country’s oil revenues by around 15pc.

The mere thought that Riyadh would be contemplating that now, with 40 years of oil money safely in the bank, is surely a devaluation too far even in these straightened times? But think on this: since the oil price collapse last year Saudi Arabia has dipped into its reserves to the tune of $60bn; it has also entered the bond market for the first time in eight years. Barclays says this could raise Saudi Arabia’s total public debt to 16.5pc of GDP next year. Yes, there are countries that would welcome that, but when that ratio was just 1.6pc as recently as last year, then there’s pause for thought.

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