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Depreciation of the dinar would not increase the competitiveness of the Serbian economy

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The relative stability of the dinar against the euro in the managed floating exchange rate regime is the optimal strategy for Serbia, and the claim that the depreciation of the domestic currency could improve the competitive position of the economy is wrong, said economist Ivan Nikolić.

“The floating exchange rate management regime achieves price stability, business certainty, security in the domestic financial system and foreign investors, while simultaneously maintaining the independence of monetary policy and the ability to adjust to strong external shocks,” Nikolić stated in the text “Who benefits from exchange rate depreciation”, published in the last issue of the monthly Macroeconomic Analysis and Trends.

He added that it is wrong to claim that the depreciation of the domestic currency could improve the competitive position of the economy, because in theory it makes imports more expensive and encourages exports.

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Nikolić said that “that erroneous statement ignores reality, and the objection related to a more “realistic” dinar exchange rate still finds a place in the public appearances of some ‘academic’ economists, is taken out of context and interpreted maliciously”.

In every open economy, as Nikolić stated, the exchange rate plays an important role in the formation of consumer prices. He pointed out that the exchange rate directly affects the prices of imported goods, regardless of whether they are durable consumer products or intermediate products and energy sources, which generate production costs, ie producer prices.

“The exchange rate affects prices indirectly, through the demand for domestic goods. When the real exchange rate depreciates, domestic goods become relatively cheaper compared to foreign goods, the demand for domestic goods increases, which has an inflationary effect, and vice versa,” said Nikolić.

He added that it is not a one-time process and that the volatility of the exchange rate and its transmission to other prices also creates negative inflationary expectations.

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According to his words, their accumulation, which goes hand in hand with the loss of trust in policy makers, creates a spiral of exchange rate growth and inflation.

“Higher inflation provokes the reaction of the monetary authorities, the tightening of monetary conditions and the growth of the reference interest rate. This potentially increases the return on investments in the domestic currency, that is, the inflow of foreign (portfolio) investment. The conversion of foreign currency into the domestic currency has the opposite effect, in the direction of strengthening the domestic currency”, said Nikolić.

The depreciation of the domestic currency, he said, statistically insignificantly boosts exports in conditions of globalization of commodity flows and expansion of supply chains.

According to him, the effect of the exchange rate is dampened by the fact that most exports are carried out by multinational corporations that usually operate with large import margins, so the exchange rate is a less significant factor in their price calculations. “In that sense, individual, open or hidden state subsidies and incentives are more attractive to them than the exchange rate,” said Nikolić.

He pointed out that in periods of extreme external shocks, when the availability of goods for which there are no domestic substitutes is limited, imports increase in value, primarily due to higher prices. This year in Europe a good part of the increase in value

import comes from, as he said, higher energy prices, while at the beginning of 2021, inflation soared with higher prices of metals and raw materials.

There is, he said, no exchange rate that can mitigate these negative consequences on the expansion of the foreign trade deficit.

In Serbia, in the first ten months of 2022, the balance in energy exchange accounted for 44 percent of the total foreign trade deficit, and last year, in the same period, with 28.2 percent.

“More than 30 percent of the increase in the total value of goods imports in this period is due to energy imports. In conditions of dramatic growth in energy prices, the depreciation of the exchange rate would only further burden production costs, investment and consumer confidence, which would result in a stronger slowdown in economic activity”, said Nikolić.

The effects of the devaluation of the domestic currency on exports, the disincentive of imports and the suppression of external imbalances can be seen in reality, as he said from the experience of Hungary and Turkey in recent years.

According to Nikolić, the Turkish forint has nominally lost 29.2 percent of its value against the euro during 2022, ending on December 6, while in the last five years it has been devalued as much as 4.3 times. Considerably slower, but equally stable, the Hungarian forint devalued, as he said, by 12.3 percent and 33.6 percent, respectively.

“It is clear that Trska has a persistent deficit of the current account of the balance of payments, within it a negative foreign trade balance that was further deepened in 2022. The depreciation of the local currency does not reduce the external gap. More expensive imported goods did not sufficiently curb demand and the lower price of Turkish labor did not provide the domestic economy with enough competitive advantages to improve the current account deficit”, said Nikolić.

Interannual inflation, as he said, in Turkey at the end of 2022 is only slightly below 85 percent, in the first two months of this year even a two-digit increase in current prices was recorded, industrial production is slowing down, in September the physical volume approached the last year’s average, it was higher by only 0.4 percent, and the standard of living of citizens is rapidly rising.

As for Hungary, according to Nikolić, it is difficult to see a significant positive effect of the depreciation of the forint. In 2022. like other European countries, the current account deficit of the balance of payments worsened due to the energy crisis.

In the first nine months of 2022, imports in Hungary, as stated in the text, are growing faster than exports, and the balance of foreign trade worsened by 8.2 billion euros, and the deficit amounted to 5.8 billion euros.

“On the other hand, the weakening value of the forint in Hungary makes it difficult to fight inflation, which in October reached 21.1 percent year-on-year. For 2023, price growth in the range of 15 percent to 18 percent is projected, although the state has limited the prices of basic foodstuffs, motor fuels, and the administration goes as far as limiting the price of housing loans”, said Nikolić, local media writes.

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