ch03_6012_IIE 04/01/04 9:20 AM Page 21 3 Measuring Currency Mismatch: Beyond Original Sin A currency mismatch refers to how a change in the exchange rate will affect the present discounted value of future income and expenditure flows. This will depend on two broad elements. One is the currency denomination of financial assets and liabilities: the more sensitive the net financial worth to changes in the exchange rate, the greater, ceteris paribus, the currency mismatch. The other is the currency denomination of future income and expenditure flows (other than returns to capital assets). Once such a broad perspective is adopted, significant differences in the degree of currency mismatch are revealed both across emerging economies and over time. As an analytical counterpoint to our proposed definition of currency mismatch, suppose one attempted to gauge aggregate currency mis- match by looking only at the share of international bonds and bank loans denominated in the borrower’s local currency—that is, suppose one used measures of original sin as a sufficient statistic for drawing inferences about aggregate currency mismatch. How might the original sin measures lead one astray? It turns out that the answer is helpful in understanding what should be included in a good measure of currency mismatch. Original Sin: A Misleading Measure Table 3.1, taken from Eichengreen, Hausmann, and Panizza (2002), gives three measures of original sin. These measures are defined as one minus the percentage of own currency–denominated securities in the relevant 21 ch03_6012_IIE 04/01/04 9:20 AM Page 22 Table 3.1 Measures of original sin by country groupings, simple average (billions of dollars) OSIN1 OSIN1 OSIN2 OSIN2 OSIN3 OSIN3 Group 1993–98 1999–2001 1993–98 1999–2001 1993–98 1999–2001 Financial centers 0.58 0.53 0.34 0.37 0.07 0.08 Euroland 0.86 0.52 0.55 0.72 0.53 0.09a Other developed 0.90 0.94 0.80 0.82 0.78 0.72 Offshore 0.98 0.97 0.95 0.98 0.96 0.87 Developing 1.00 0.99 0.98 0.99 0.96 0.93 Latin America and the Caribbean 1.00 1.00 1.00 1.00 0.98 1.00 Middle East and Africa 1.00 0.99 0.97 0.99 0.95 0.90 Asia Pacific 1.00 0.99 0.95 0.99 0.99 0.94 Eastern Europe 0.99 1.00 0.97 0.98 0.91 0.84 a. For 1999–2001, it was impossible to allocate the debt issued by nonresidents in euros to any of the individual member countries of the currency union. Hence, the number is not the simple average but is calculated taking Euroland as a whole. =−Securities issued by country i in currency i OSIN11i Securities issued by country i OSIN2i = max(INDEXAi, OSIN3i) Securities+ loans issued by country i inmajor currencies where INDEXA = i Securities+ loans issued by country i Securities in currency i INDEXB =−1 i Securities issued by country i Securities in currency i OSIN31=−max , 0 i Securities issued by country i Notice that OSIN2 > OSIN3 by construction and that, in most cases, OSIN1 > OSIN2. Source: Eichengreen, Hausmann, and Panizza (2002). total, so that the closer the ratio to one (zero), the greater (smaller) the original sin and implied currency mismatch. These original sin calcu- lations suggest that currency mismatch is pervasive in all developing- country groups, and the mismatch has been persistent over 1993–2001. Another strong implication of table 3.1 is that developing countries face a much larger currency mismatch than not only issuers of the five major currencies but also small industrial countries. Using original sin as a measure of aggregate currency mismatch would be misleading on at least five important counts. First, it ignores cross-country differences in export openness, reserve holdings, and the size of foreign assets more generally, which can be crucial for assessing currency risk. Consider two net debtor countries (A and B) that have iden- tical shares of foreign currency–denominated debt in total external debt. 22 CONTROLLING CURRENCY MISMATCHES ch03_6012_IIE 04/01/04 9:20 AM Page 23 Table 3.2 Export openness, 1994–2002 (exports as a percent of GDP) Region/country 1994 1995 1996 1997 1998 1999 2000 2001 2002 Latin Americaa 14.4 16.9 17.7 16.9 16.3 18.0 19.5 19.2 22.5 Argentina 7.5 9.7 10.4 10.6 10.4 9.8 12.5 11.5 27.7 Brazil 9.5 7.7 7.0 7.5 7.4 10.3 10.7 13.2 15.8 Chile 29.3 30.5 27.3 27.1 26.3 29.3 31.7 34.7 34.0 Colombia 15.0 14.5 15.2 14.8 15.0 18.3 21.5 20.8 19.7 Mexico 16.8 30.4 32.1 30.3 30.7 30.8 31.0 27.4 27.2 Peru 12.8 12.5 13.1 14.2 13.2 14.7 16.0 15.8 16.1 Venezuela 30.9 27.1 36.5 28.4 19.9 21.6 28.4 22.3 31.4 Asia, large economiesa 20.8 21.0 20.7 22.6 23.4 23.1 26.4 25.6 28.2 China 22.0 21.0 20.9 22.9 21.7 22.1 25.9 25.1 29.3 India 10.0 11.0 10.6 10.9 11.2 11.8 13.8 14.2 15.2 Korea 27.8 30.2 29.5 34.7 49.7 42.3 44.8 42.8 40.0 Taiwan 43.9 48.5 48.4 49.0 48.4 48.0 54.0 50.2 53.7 Other Asiaa 37.9 39.6 39.1 44.0 60.4 53.5 60.4 57.5 54.4 Indonesia 26.5 26.3 25.8 27.9 51.2 34.9 42.4 41.1 34.7 Malaysia 89.2 94.1 91.6 93.3 115.7 121.3 124.8 116.3 113.8 Philippines 33.8 36.4 40.5 49.0 52.2 51.5 56.2 49.0 51.7 Thailand 38.9 41.8 39.3 48.0 58.9 58.4 67.0 66.4 64.8 Central Europea 31.8 36.5 36.5 39.4 42.9 42.7 48.8 48.4 45.7 Czech Republic 50.5 53.6 52.5 56.5 58.8 60.6 69.8 70.8 65.2 Hungary 28.9 44.4 48.5 55.1 62.6 65.2 74.9 74.4 64.5 Poland 23.8 25.4 24.4 25.6 28.2 26.1 29.4 28.4 29.6 Russia 27.8 26.9 24.2 23.9 30.6 43.8 44.1 36.2 34.4 Israel 32.6 30.6 29.8 30.4 31.6 36.0 40.6 35.5 36.9 Turkey 21.4 19.9 21.5 24.6 24.3 23.2 24.0 33.7 28.9 South Africa 22.2 23.0 24.6 24.6 25.7 25.7 28.6 30.6 34.0 a. Weighted average of countries shown, based on 1995 GDP and PPP exchange rates. Note: Exports include goods and services per the national accounts definition, except China and Taiwan, for which the balance-of-payments definition is used. Sources: IMF’s International Financial Statistics and national sources. Assume country A has twice as high a ratio of exports to income as coun- try B. Should it then be concluded that the two countries face an identical currency mismatch? Of course not. Both sides of the net income statement and the balance sheet are relevant for gauging the extent of the currency mismatch. For most of the past decade, Argentina and Brazil, for exam- ple, have had ratios of exports to GDP that hovered in the 7 to 13 percent range—less than half that of Mexico and Chile and less than a fifth that of typical Asian emerging economies (table 3.2).1 At identical original sin ratios, Argentina will, ceteris paribus, have a much larger currency mismatch than Mexico or Singapore. The same line of argument about 1. Argentina’s ratio of exports to GDP mushroomed in 2002 because of the deep recession and the effects of the sharp fall in the peso exchange rate on both GDP measured in dollars and export earnings. MEASURING CURRENCY MISMATCH 23 ch03_6012_IIE 04/01/04 9:20 AM Page 24 cross-country differences also applies to holdings of international reserves and foreign assets more broadly. Whereas monetary authorities of some emerging economies, such as Korea and Malaysia, have net foreign assets (in 2002) that are five to seven times larger than currency held outside banks, those in others, such as the Philippines, Brazil, and Poland, have much lower ratios (less than three). Likewise, data on net international investment positions taken from the IMF’s Balance of Payments Yearbook reveal sharp differences among emerging economies. For example, for- eign assets (in 2002) accounted for less than 10 percent of foreign liabili- ties in Ecuador but for 66 and 86 percent in Chile and the Czech Republic, respectively; in Hong Kong and Singapore, foreign assets exceed foreign liabilities (i.e., they are net creditors, not net debtors).2 Since our preferred measures of currency mismatch consider both assets and liabilities, they are not subject to this pitfall.