Why is a currency is overvalued it may encourage excessive borrowing by an emerging market governmet?
My guess, no one would buy a thing from the country, so it will not be able to generate income. Thus, it needs to borrow money???
Thanks in advance
Think of it the same way a company would be more likely to issue stock (or aquire a company using stock) if that stock is overvalued.
If the currency is overvalued to take advantage of this pricing discrepancy the government would increase borrowing since they could get more Euros per unit of domestic currency, hence it’s relatively cheaper to pay back.
I would caveat this with “if currency moved toward intrinsic value.”
As fellow AFer pointed out (see their feelings below), when writing responses they need to be air tight up in to and including the most obvious.
@ OP - as you begin your preparation, there is tremendous value in approaching the Level III curriculum by constantly thinking “how can I explain this concept in a few bullet points” and practicing doing so from the start. It will surely carry you through exam day. Good luck.
Mmmhh, is it so…? In level 1 they told us that Y=C+I+G+X–M X–M is exports minus imports. The point of paragraph 4.4.3.2. “Country Risk Analysis Techniques” (sub 3.) is that emerging market economies cannot manage their own currency to any significant extent. An overvaluation will most likely be the result of difficult-to-control market forces. Nowhere it is said that the hypothetical country is targeting an overvaluation (hence it is a long shot to conclude that the country is taking advantage of a pricing discrepancy). If market forces cause the nominal exchange rate of a country to be out of whack with the real exchange rate so that its currency is overvalued vs another for a prolonged period of time, this causes (X-M) in the country whose currency is overvalued to be <0. This results in a current account deficit that needs to be financed by an equivalent increase in the country net foreign debt as “only by borrowing money from foreigners can a country have a current account deficit and consume more output than it produces.” (Level I – book 2). To draw this crisp post to a close and to quote a fellow candidate “it is September for god’s sake …”. Candidates who will sit the level 3 exam next June would be better advised to get a decent grasp on the material before turning their attention to distilling the said material into a neat bullet point. This forum provides an excellent opportunity for collabortion and sharing but we should be mindful that, in absence of any sort of moderation, anyone with an internet connection can write as much nonsense as he sees fit and it is up to candidates (for the benefit of the present and future community) to challenge a poor answer to a good question lest none with a gram of sense will soon bother to post good questions at all and all we are going to be left with is 3/3, 18 months, how big is the charter, where it is best to hang it, accounts from the latest pissing contest and other amenities of similar nature…
Minus the snarky attitude, much more developed response. Very helpful and happy to admit to agreeing with lesser quality response. I stick by my advice with respect to writing and keying in on distilling content into bullet points early on. I believe thoroughly grasping the material goes without saying, but to AWPerator’s point, have got to spell it all out. Touche…
That said, you’re right, it’s September, it’s still a drought for 2016 content. Now back to the short vs. long error message debate.