Relative development stages in the global economy are normally measured by using Gross Domestic Product (GDP) figures calculated per head of population. Obviously, these figures must be converted into one single currency, normally into USD, or EUR, in order to be able to make international comparisons. The Vienna Institute (WIIW) provides GDP figures on countries under review converted into EUR.
Unfortunately, there is no guarantee that official exchange rates convert various currencies into EUR correctly. As pointed out above, price levels within enlarged EU vary from country to country. EUR 100 buys more goods and services in a poor country than in a rich one. If that is the case, it is said that the currency in the poor country is undervalued at the current exchange rate. Therefore, GDP calculations per capita are made more accurate if TE currencies are converted into EUR on a purchasing power parity (PPP) basis. That means that exchange rates need to be adjusted such than an identical “consumer basket” costs the same in
one country as another. Vienna Institute has a long tradition in calculating PPP adjusted GDP
In the above table, A figures represent the “raw” data of GDP in countries under review plus EU (15), which is Western Europe. These figures indicate that there is a considerable gap in living standard between Western Europe and post-communist countries.
Column B contains GDP figures per capita PPP adjusted. B-figures in TEs are clearly higher than A-figures, which means that PPP adjusted reduces the living standard gap between East and West considerably by taking relatively cheap price levels in TEs into consideration. It can also be stated that A-figures count the nominal and B-figures the “real” living standard in countries concerned.
Actually, A and B figures ought to be identical. In that case all official exchange rates would correctly reflect price levels in countries involved. One to one relationship is equilibrium ER.
It is also said that ER is in parity when A equals B.
As B figures deviate from A figures in the above table, in different manner, it is useful to measure what are degrees of this deviation in different TEs. Exchange rate deviation index (ERDI) can be established by dividing B figures by A figures. If ERDI value is over one it indicates that the currency in question is undervalued. ERDI value below one tells us that the country has an overvalued currency.
In the above table Bulgaria has the highest ERDI value, about 2,5. It means that if somebody buys an average consumer basket in euro-area for 100 EUR, he/she can get 2,5 similar
“baskets” in Bulgaria with the same banknote (100 EUR). Prices in Bulgaria are essentially lower than in EU in average, as pointed out above.
Occasionally, undervaluation of a currency is called “exchange rate protectionism”. It makes exportables cheap and importables dear. Therefore, countries with a relatively low development stage need protection provided via undervalued currency.
Even if Bulgarian currency is grossly undervalued (high ERDI figure), she has very high current account deficit. Therefore, it can be assumed that Bulgaria needs undervaluation of her currency for several years to come.
Generally speaking, undervaluation advantage has eroded over time in many TEs. With improvement of export quality, price competitiveness becomes less important. Export quality and import substitution normally improve via FDI inflow. Many foreign-owned companies in TEs are strongly export-oriented and produce goods locally substituting imports, and thus, help to keep the local current account in relative equilibrium.
The erosion of undervaluation advantage can be measured by index figures covering the development of real ERs. There is a difference between nominal and real exchange rates. The latter is more important than the former.
A country’s international competitiveness depends on relative prices. For example, if prices in Estonia increase by 4% and 2% in euro-area, Estonia’s price competitiveness falls by 2% in this two-country model. In a theoretical case of perfect market with floating ERs, Estonian currency would depreciate by 2% re-establishing the original competitiveness of Estonia.
However, in real life Estonia has a fixed ER regime (fixed against euro). If Estonia has higher inflation rates than euro-area, her currency appreciates against euro hurting her competitiveness. In that case Estonian undervaluation advantage erodes, which is hampering current account balancing act.
Measures of overall competitiveness are known as “relative prices expressed in a common currency”, or simply real exchange rates. Vienna Institute serves index numbers concerning development of real ERs in TE-region.
Table 13. Real ERs against EUR, 2007
Source: WIIW * CPI = Consumer Price Index
* PPI = Producer Price Index
Very often consumer price index is taken as a proxy of overall inflation measurements. The above table contains two real ER trends, one based on consumer price index, and the other on producer price index. In both cases, there is an increasing trend visible.
In the CPI-based calculation, there is one exception of the rule. In Latvia, real ER decreased somewhat between 2000 and 2007. In the PPI-based column, there was an increase of over 9%. Thus, it can be maintained that ER in Latvia has been in general terms rather stable during the current decade in real terms. However, Latvia has the highest relative deficit of current account 2006 - 2007 in the countries under review.
Latvia with relatively low living standard has maintained the degree of her currency’s undervaluation during the first years of the 21st century. This undervaluation is not deep enough to secure a relative equilibrium in her current account. In order to reduce her current account deficit, which is extremely high, she ought to have a clear depreciation of the real value of her currency. As shown in the above table, this is not taking place. A balancing act in current account presupposes a clear depreciation of real ER in Latvia.
Slovenia’s index figures in the above table hint on relative stability of her real ER in the period under review. Slovenia’s current account had a higher deficit 2007 than 2006. In 2007 Slovenia joined the euro-zone, which means that she can not use the devaluation tool in the conventional way any more. Slovenia’s current account deficit is rather modest, less than 5%
of GDP. In Latvia the equivalent figure is almost 5 times higher.
On the other end of the scale, Slovakia has the highest index figure in the first column of the above table (the CPI-based calculation). It means that her real ER has appreciated faster (2000
- 2007) than in any other TE under review. The figure in the second column (based on input price index) is rather high with 153. However, Slovakia’s current account deficit went down from 7% 2006 to 4,7% (of GDP) 2007.
In the first years of this century, Slovakia has received plenty of FDIs, especially in the branch of car manufacturing. Foreign companies are strongly export-oriented in Slovakian case. Therefore, her export performance has improved considerably in resent years, which is visible in her current account balancing act. In sum, Slovakia has been able to manage her current account rather well in spite of the clear appreciation of her real ER.
As pointed out above, Russia is a special case among the selected countries. Her current account surplus is determined by external factors (high prices of oil, gas, metals), not by her ER.
In the above index, it is visible that Russian ER has appreciated by more than 53% in the CPI-based and almost 90% in the PPI-CPI-based calculation (2000 – 2007). This strengthening of the RUB value hurts obviously import substituting branches. Especially those local production branches, which are dealing with input goods (construction materials, machines, commercial vehicles, etc) are losing price competitiveness rather rapidly. Also in the sphere of consumer goods local offers are getting more expensive than the imported ones.
Bulgaria and Romania are the least developed NMSs in the above table, and thus, need price competitiveness very badly. In both cases, real ER has appreciated clearly hurting competitiveness. In Romania, PPI-based index figure has strongly increased between 2000 and 2007, no less than 66%. This is no good news from Romania’s current account point of view. Romania’s current account deficits (2006, 2007) are critical, but not as critical as in Bulgaria.
In the Baltic region, Estonia and Lithuania show less dramatic current account deficits than Latvia. However, both countries have double digit current account deficits with increasing tendency. Thus, in both cases ERs ought to depreciate and not appreciate.
CPI-based real ER appreciation in Estonia was about 14% (2000 – 2007) and the equivalent PPI-based figure was about 8%. In Lithuania the corresponding increases were about 5% and 18%, respectively.
In the above table, Estonian and Lithuanian results are comparatively good. Also in Poland, real ER appreciation is rather modest in the period under review.
The higher the figures in two columns of the above table are, the more is the “undervaluation advantage” in the region eroding. The only decline in the above table can be observed in Latvian consumer price index based real ER 2000 – 2007. All other figures show growth indicating real appreciation of ERs, and thus, deteriorating price competitiveness.
In Central Eastern Europe (Czech Republic, Hungary, Poland, Slovakia, Slovenia) national economies have been able to digest the tendency of appreciating real ER relatively well. No country in this region shows a higher than 5% (of GDP) deficit in current account. This is not the case in Bulgaria, Romania and the Baltic States. All five countries have double digit current account deficits, which are not sustainable on the long run. Russia with her current account surplus is a special case.
Real appreciation of a local currency ER affects potentially FDI inflow. Especially export-oriented investors are obviously avoiding locations with strongly appreciating currencies.
It is worth noticing in this context that not only the speed of appreciation of an individual currency, but also the original level of its undervaluation affects the scene. It was pointed out above, that Bulgaria has the most severe undervaluation advantage in the region under review.
Therefore, she can offer the cheapest cost level in the region, even if her currency appreciates for a while. Romania is roughly on the same development stage with Bulgaria with higher cost level and more rapid appreciation of real ER. Thus, Bulgaria is gaining cost competitiveness vis-à-vis Romania.
3 Conclusions
In the early years of the 21st century, Russia has experienced a strong economic boom with rapidly increasing export prices. Thus, her importance in the global economy has increased.
Brazil is, alongside with Russia, an economy with extensive resource base. However, Brazil is not a major exporter of oil. In the near future, Brazil’s position is likely to change, because a huge oil well has been found in her territory.
There are two countries in the world with a population of one billion, China and India, both of which have had extremely rapid economic growth in recent years. In economic language a new term, BRIC, has appeared, meaning Russia, Brazil, India and China. The weight of this group of countries in the global economy is increasing rapidly.
World Bank’s “World Development Report 2008” provides Gross National Income (GNI) figures of almost all countries of the world. This data is available in US dollars calculated according to official ERs, as well as purchasing power parity adjusted. GNI figures at PPP give a realistic picture of economic activity in different national economies.
Russia’s share of the overall economic “cake” of the globe is 2,5 %, which is just the same as Brazil’s equivalent figure. Brazil has almost 50 million people more, than Russia. China produced 2006 about 15 % of global GNI, while America’s equivalent slide is about 20 %.
Germany, the biggest EU-country, makes about 4 % of the global output.
In per capita terms, America’s GNI at PPP is about four times higher than that in Russia. In the same measurement Germany is about three times better off than Russia, which is richer than China and Brazil.
World Bank’s figures show that the share of manufactured goods in Russia is only 19 % of total exports. The equivalent figure in the other resource-rich country, Brazil, is 54 %. In Chinese export statistics manufactured goods have a dominant 92 % share, which is the same in Japanese case.
Thus, the economy of Russia is clearly “resource based”, while the Chinese economic miracle is built on manufacturing. In the latter case, investment quota is over 40 %, which is about twice as high as in the former. Both countries earn current account surpluses.
Fortune magazine publishes every year a list of 500 biggest companies in the world. The biggest Russian company, the gas giant Gazprom, is on the 52nd place in this list 2006. All Russian companies involved in this list of international giants are active in oil and gas sector.
In the second part of the report some comparisons are brought up between Russia and ten new EU members. In the light of Vienna Institute (WIIW) figures, Russia’s living standard, GDP per capita at PPP in Euro, is lower than in the three Baltic states, which were members of the former Soviet Union. Russia is better off than Romania and Bulgaria, the post-communist countries with delayed EU-membership.
Russia’s currency is still clearly undervalued. However, her undervaluation advantage is gradually melting away. Rouble appreciates against euro in real terms.
Russian average gross wages have increased very rapidly in the first years of the new century.
Alongside with strong nominal wage increase also purchasing power has grown fast. Unit labor costs have expanded enormously, which indicates that Russia’s international competitiveness deteriorates. This trend has a rather limited effect on exports, which are mainly resource-based (oil, natural gas, metals). Declining price competitiveness is undoubtedly hurting import substituting activities. Imports have increased by almost 30 % a year in the last three years. However, Russia’s current account still had a 6 % (of GDP) surplus in 2007.
Therefore, it can be concluded that Russia’s economy can afford to have a rather high inflation of somewhat under 10 % annually, without entering a phase of “overheating”.
Several TEs in Europe have very serious current account problems.
Russia has benefited from global energy price hikes in the period under review, while other TEs have suffered in the relative energy crisis. Oil and gas markets are not necessarily cooling down via economic slowdown in some mature economies.