Don't hike rates to prop up battered currencies: UN
Saturday, 20 December 2008
GENEVA, Dec 19 (BSS/AFP) - Countries struggling with the falling value of their currencies should resist hiking interest rates to prevent devaluations, the UN warned yesterday.
"Rising interest rates and falling government expenditure will only reinvite speculation and worsen matters in the real economy," said the UN Conference on Trade and Development (UNCTAD) in a policy newsletter.
It added: "Raising interest rates to avoid further devaluation is rather like the tail wagging the dog."
Rather, countries should apply "expansionary fiscal and monetary policies" such as lowering lending rates, in order to boost domestic demand.
UNCTAD called for a fresh look at the world's exchange rate system, saying that a multilateral or global arrangement is necessary to prevent a overshooting of the devaluation in these currencies.
"Unless there is a fundamental rethinking of the exchange rate mechanism and the cost involved in the traditional 'solution' of assistance packages without symmetrical intervention, the negative spillover of the financial crisis into the real economy will be much higher than needed," it said.
UNCTAD cited Brazil, Hungary, Iceland, Romania and Turkey as countries facing devaluations.
In Hungary, as in other eastern European countries, many private households have borrowed increasingly in foreign currency because forint interest rates were higher.
About 60 percent of Hungary's private debt is denominated in euros and Swiss francs.
But the financial crisis forced a sharp depreciation of the forint, and lenders thereby saw their debt balloon under the unfavourable exchange rate, resulting in defaults.
To support the forint, the Magyar Nemzeti Bank hiked lending rates by three percentage points in October, before easing it back twice in November and December, each time by half a percentage point.
Iceland also hiked rates by 6.0 points to 18 percent at the end of October as the country battled to avoid a national bankruptcy.
"Rising interest rates and falling government expenditure will only reinvite speculation and worsen matters in the real economy," said the UN Conference on Trade and Development (UNCTAD) in a policy newsletter.
It added: "Raising interest rates to avoid further devaluation is rather like the tail wagging the dog."
Rather, countries should apply "expansionary fiscal and monetary policies" such as lowering lending rates, in order to boost domestic demand.
UNCTAD called for a fresh look at the world's exchange rate system, saying that a multilateral or global arrangement is necessary to prevent a overshooting of the devaluation in these currencies.
"Unless there is a fundamental rethinking of the exchange rate mechanism and the cost involved in the traditional 'solution' of assistance packages without symmetrical intervention, the negative spillover of the financial crisis into the real economy will be much higher than needed," it said.
UNCTAD cited Brazil, Hungary, Iceland, Romania and Turkey as countries facing devaluations.
In Hungary, as in other eastern European countries, many private households have borrowed increasingly in foreign currency because forint interest rates were higher.
About 60 percent of Hungary's private debt is denominated in euros and Swiss francs.
But the financial crisis forced a sharp depreciation of the forint, and lenders thereby saw their debt balloon under the unfavourable exchange rate, resulting in defaults.
To support the forint, the Magyar Nemzeti Bank hiked lending rates by three percentage points in October, before easing it back twice in November and December, each time by half a percentage point.
Iceland also hiked rates by 6.0 points to 18 percent at the end of October as the country battled to avoid a national bankruptcy.