Crisis vulnerability ratios
Reserve adequacy = reserves / short-term external debt (benchmark >= 1)
Debt service ratio = debt service payments / export earnings (watch above 20 %)
Import cover = reserves / monthly imports (benchmark >= 3 months)
External debt / GDP = (debt in foreign currency x exchange rate) / GDP
Screening any emerging market for the crisis anatomy, and any news article that calls a country vulnerable. These benchmarks are standard practice rather than deck content, so check them against your class slides.
- short-term external debt
- Obligations falling due within a year, which must be refinanced. Long-term debt does not belong in this ratio
- export earnings
- The denominator of the service ratio, because debt service must be paid in foreign currency
The balance sheet effect
debt in domestic currency = foreign currency debt x exchange rate
new debt/GDP ratio = old ratio x (new rate / old rate)
rise in points = old ratio x (factor - 1)
Example: 40bn at 25 -> 100 per dollar takes debt from 12.5 % to 50 % of GDP
Whenever a question involves a devaluation in a country with foreign currency debt. It explains why a depreciation can be contractionary even when Marshall-Lerner holds.
- factor
- New rate divided by old rate. The debt ratio scales by it one for one
- falling GDP
- The crisis also cuts real output, so the denominator falls and the ratio rises further
Rate rise against loss of value
% rise in the rate = (new rate - old rate) / old rate
% loss of value = 1 - (old rate / new rate)
They are DIFFERENT numbers: 30 to 45 is a 50 % rise and a 33.3 % loss
Any question or headline about a currency falling. State which convention you are using, because both are correct about the same event.
- rise in the rate
- What an importer experiences: foreign goods cost this much more
- loss of value
- What a headline usually quotes: the currency fell this much
The five questions for a news article
1 Which account? current, capital, or reserves
2 Which direction? does R rise or fall, and what does that do to the number
3 Which mechanism? price, income, monetary, or policy
4 Which zone? internal and external together: Swan zone I, II, III or IV
5 Which instrument, and what does it break?
Sessions 19-20 are delivered as a report or news article, and the assignment carries 15 per cent. Use this as the skeleton of any applied commentary. Check against your class slides.
- step 4
- Zones I and III need one instrument; II and IV need two, by Tinbergen's principle
- step 5
- Every instrument has a second effect. Naming it is what separates an answer from a summary