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Forex Fundamental Analysis

How The ‘Corruption Rank’ Data Impacts A Nation’s Currency

Introduction

Corruption can very well be defined as seeking private gain through abuse of power that one has been entrusted. The biting effects of corruptions include:

  • Erosion of confidence in the monetary and economic system;
  • Hampering economic development;
  • Increase in current account deficits; and
  • Encouraging the growth of shadow economies

So, how does this affect a country’s currency valuation? Well, through GDP, of course! This correlation is explained in detail later on in this article.

Understanding Corruption Rank

Corruption rank is the ranking of countries worldwide based on how the countries’ public sector has been corrupted. It measures the extent of corruption by politicians and other public officials. Due to its nature of illegality and secrecy, there is no single indicator that directly measures the levels and extent of corruption in each country. The best measure of corruption rank is the Corruption Perceptions Index (CPI) published by Transparency International.

The CPI is used to rate the countries based on perceived levels of corruption on a sliding scale from 0 to 100. A score of 0 is considered the most corrupt. A country with a score of 100 is considered to be clean of corruption. The CPI is constructed based on the opinions of business executives, public policy experts, financial journalists, and risk analysts globally.

The CPI is a result of 13 rigorous assessments and surveys on wide-ranging issues on corruption collated by several reputable institutions around the world, including the World Bank and African Development Bank. These assessments and surveys are conducted in the two years preceding the publication. They incorporate a combination of qualitative and quantitative analysis which captures the manifestations of corruption, including:

  • Misuse of public resources;
  • Effectiveness of the prosecution of corruption cases by the judiciary;
  • The extent of bribery by firms and individuals to secure contracts, avoid taxations and payment of duties;
  • Bureaucratic loopholes that foster corruption; and
  • The effectiveness of anti-corruption measures implemented by the government

How Corruption Rank Impacts the Economy

To better understand how the corruption rank of a country influences its currency, we first must understand how corruption impacts a country’s economy.

Corruption inherently impacts the economy negatively. A specific study by the World Bank shows that the GDP per capita in countries with low CPI is about 60% less than for countries with a higher CPI. The negative effects of corruption are:

Overreliance on debt

Corruption results in a significant leakage in the budget. A country is thus forced to rely on debt, usually denominated in foreign currency. The interest payment leads to a higher share of revenue allocated to repayment in the short term instead of economic investments. This higher share of foreign borrowing also results in the local currency crisis.

Inefficiencies in the allocation of resources

Through bribery, the allocation of tenders is usually awarded to individuals and firms who are not qualified. As a result, most public projects are not completed, and the benefits to the economy foregone.

Creation of a shadow economy

Corruption facilitates the growth of several firms that avoid official registrations. As a result, the economy experiences a deficit in terms of taxation, import, and export duties payable. Consequently resulting in low GDP.

The exit of investors

Corruption leads to investors pulling their businesses out. This exit leads to reduced economic activities and accompanied by job losses.

A lower share of foreign direct investment (FDI)

Foreign investors often shun countries with rampant corruption since they seek a fair operating environment. Donor agencies such as IMF and World Bank also reduce their total outflows into such countries. Therefore, the recipient countries’ economy fails to benefit from such investments, which would have a multiplier effect within the economy. Also, because FDI is usually denominated in foreign currency, it usually boosts the recipient countries’ currency strength.

Reduced innovation

Corrupt countries offer very little protection in terms of patents and copyright protection. The lack of legal protection framework results in massive exportation of technology from such countries, thus denying the local economies the growth benefits.

Increase in current account deficits

Corruption creates a disincentive to invest in the local manufacturing and production industries. Apart from the drop in job creations, this leads to overreliance on importation to fill the local demand.

There is a direct inverse relationship between corruption levels in a country and its currency. The inverse correlation is because countries with higher perceptions of corruption have poor economic performance, while those with lower perceptions of corruption have better economic performance.

Consequently, a change in the corruption ranking is often accompanied by a corresponding change in the country’s GDP. In 2019, Sweden dropped in ranking from position 3 to position 4; this was coincided by a 6.37% drop in its annual GDP. During the same period, Malaysia ranked position 51 from 61, a period which coincided with a 1.68% annual GDP growth.

Source: ResearchGate 

How Corruption Rank Impacts a Currency

Although it is a rarely observed indicator, forex market investors should keep an eye on the annual release of the corruption rank. Because the corruption rank is based on two years’ worth of data, it is evident that the corruption rank signifies the underlying fundamental changes in a country’s economy.

High levels of corruption typically tend to be accompanied by a deteriorating economy. It is a known fact that the strength and fluctuation of a country’s currency are tied to its economic performance. Therefore, this is accompanied by a reduction in the valuation of the currency in the forex market.

Any improvements in the rank could forebode that the economy has been performing better, which will be accompanied by a significant appreciation in the country’s currency. Conversely, a drop in the corruption rankings signifies a deterioration in the economic conditions, which will result in the long-term changes in the currency’s value.

Sources of Data

The corruption perceptions index and the corruption rank are released annually by Transparency international. The corruption perceptions index can be accessed here and the corruption rank here.

How Corruption Rank Release Affects The Forex Price Charts

The corruption rank published annually by Transparency International rarely moves the forex market. It is, however vital for the forex traders to keep an eye out for CPI rank. As we have already discussed in this article, the CPI provides crucial information about the conditions of the underlying fundamentals of a country’s economy. The corruption rank is released annually following a two-year assessment and analysis. The latest CPI data for 2019 ranking 198 countries was released on January 23, 2020. A highlight of the release can be found on the Transparency International’s website.

Below is a snapshot of the top and bottom performers. The legend indicates the level of corruption in the country.

In 209, the US fell in rankings by one position, from 22 to 23 out of the 198 countries that were ranked. The screengrab below shows this position.

EUR/USD: Before Corruption Rank release on January 23, 2020

On the above chart, we have plotted a 20-period Moving Average on the EUR/USD chart. As can be seen, the pair had been on a consistent downtrend on the four-hour candlestick pattern. This downtrend is evident since the candlesticks are trending below the 20-period Moving Average. This similar downtrend on the four-hour candlestick chart can be observed on GBP/USD and NZD/USD, as shown by the charts below.

AUD/USD: Before Corruption Rank release on January 23, 2020

NZD/USD: Before Corruption Rank release January 23, 2020

For long-term traders, the pattern offers a great opportunity to go short on the above pairs, since the prevailing downtrends would favor them. Let’s now see how the price responded to the release of the corruption rank by Transparency International.

EUR/USD: After Corruption Rank release on January 23, 2020

After the release of the corruption rank, a persistent downtrend in the EUR/USD pair can still be observed. As shown on the daily chart above, the EUR/USD pair had a bullish candle on January 23, 2020. This strength is even though the US dropped in the corruption rank. Its CPI score dropped from 71 in 2018 to a score of 69 in 2019.

However, against the AUD, the USD can be observed to have weakened momentarily. The pair later regained its bullish trends. It is worth noting that the momentary strength in the AUD is because Australia performed better in the corruption ranking by climbing one position, as shown by the snapshot below.

The chart below shows the daily price action of the AUD/USD pair after the news release.

AUD/USD: After Corruption Rank release on January 23, 2020

The USD weakened against the NZD after the release of the corruption ranking. This weakness can be attributed to the fact that New Zealand ranked first with a score of 87. This ranking is shown by the screengrab below.

As can be seen on the daily chart below, USD weakened against the NZD after the news release.

NZD/USD: After Corruption Rank release on January 23, 2020

Corruption rank can be seen to have some mild effects on the price action of the selected pairs, but not enough to alter to the trend observed before its release. Although most forex traders rarely observe it due to the annual nature of its release, corruption rank provides vital information about the underlying fundamentals of an economy. All the best!

Categories
Forex Fundamental Analysis

Why Understanding ‘Corruption Index’ Is Crucial In Determining Economy’s Health?

Introduction To Corruption Index

The corruption index is a score that is given to the government of a country, which indicates the degree of corruption in the country. The value is assigned from 0 to 100, with 0 indicating high levels of corruption and 100 indicating low levels. The score is given by Transparency International, an organization that tries to stop bribery and other forms of corruption activities in the country. Transparency international started ranking in 1995, and today it scores more than 176 countries and territories.

The Corruption Index focusses on the public sector and evaluates the degree of corruption among public officials and politicians. In highly corrupt countries, the judiciary’s quality and independence are usually low, and official statistics try to underestimate the level of corruption to hide the bitter truth. The international agencies are a valuable alternative source of information to report the extent of illegal practices being done by civil servants and politicians in a given country.

Impact of corruption on the economy  

Most economists view corruption as a key obstacle to economic growth. It is seen as one of the reasons for low income and plays a critical role in generating poverty traps. It prevents economic and legal systems from functioning properly. Other effects are a misallocation of talent or human development, reduction in the incentive to accumulate “capital.”

Corruption hampers development by allowing agents to interfere in the usual functioning of the government. Economists believe that corruption is like a competitive auction; those who want a service, use the power of money to get it, and the result is an inefficient allocation of resources. The resources get used by people who do not deserve or are not meant to use it.

Contrary to this idea, some people argue that corruption ‘greases’ the wheels of development and that foster growth. The main idea is that corruption facilitates beneficial trades that otherwise would not have taken place. In this way, it promotes productivity by allowing individuals in the private sector to correct or avoid government failures of various sorts.

Limitations of Corruption Index

The index has been criticized lately based on its methodology used for ranking countries. Political scientists find some flaws in the way the corruption index is calculated. These flaws include:

  • Corruption data is too complex to be captured by a single source. For example, the type of corruption in rural Michigan will be different from that in the city administration of Chicago, yet the index measures them in the same way.
  • It is seen that the corruption index is influenced by perception about it. It means it is not measured by considering its real value, where the index may be reinforcing existing stereotypes and clichés.
  • The index only measures public sector corruption and ignores the private sector. This means the well-publicized scandals such as the Libor scandal, or the VW emissions scandal were not included in the corrupt segment.

 Analyzing the data

Corruption index is an important economic indicator that most economists and money managers look at before making investments. In recent times, it is making a huge impact on the economic development of a country. Thus, we need to understand how the data is analyzed. By comparing the two countries’ rankings, one can determine which of the two economies is stronger and enjoying investor confidence.

While analyzing the data, it important to keep in mind that economies of the same stature should be compared. We cannot compare the ranking of a developed country with that of a developing country. This is because corruption has a much greater impact on the growth rates of developing countries.

Impact on currency

Public corruption in emerging countries, especially, contributes to currency crises and put a major dent in the development of the country. Corruption acts repel stable forms of foreign investment and leave countries dependent on foreign bank loans to finance growth. Foreign investors refuse to put their money in developing countries where, for example, local bureaucrats accept bribes, and the government has been known to fall prey to businesspersons and builders.

A corrupt government may be undesirable for foreign direct investment (FDI), but it may not be equally disadvantageous when it comes to obtaining loans from international creditors. This is because governments of most countries offer considerably more insurance and protections to lenders than to direct investors. The result is a country with high debts and no foreign investment. Such an imbalance leaves an economy much more vulnerable to currency crises.

Sources of information on Corruption Index

The Corruption Index is published annually by Transparency International since 1995, which ranks countries by their perceived levels of corruption in the public sector. Transparency International is the official agency that keeps track of the corruption activities and wrongdoing of the government, which is reflected in the rankings. However, other economic websites measure corruption based on their parameters and factors. They also provide a statistical comparison of different countries with a clear graphical representation.

GBP (Sterling) – https://tradingeconomics.com/united-kingdom/corruption-index

AUD – https://tradingeconomics.com/australia/corruption-index

USD – https://tradingeconomics.com/united-states/corruption-index

CAD – https://tradingeconomics.com/canada/corruption-index

NZD – https://tradingeconomics.com/new-zealand/corruption-index

JPY – https://tradingeconomics.com/japan/corruption-index

The corruption index is gaining a lot of attention and importance around the world. Corruption decreases the amount of wealth in a country and lowers the standard of living. The economic impact of corruption is measured in two ways, first, the direct impact on the GDP growth rate and, secondly, an indirect impact on human development and capital inflow. The new methodology used by Transparency International uses four basic steps, including the selection of data, rescaling source data, aggregating the rescaled data, and a statistical measure indicating the level of certainty. The data collection and calculations are done by two in-house researchers and academicians.

Impact of Corruption Index’s news release on the Forex market 

The Corruption Perception Index (CPI) scores countries on how corrupt a country’s public sector is perceived to be by experts and business executives. It is a composite index, which is a combination of 13 surveys and assessments. The data is collected and compiled by a variety of reputed institutions.

The CPI is the widely used indicator of corruption all over the world. The corruption index is closely watched by investors who take investment decisions based on the ranking. However, it has a long-term impact on the currency, and the effect may not be seen immediately after the official news release.

In this section of the article, we will observe the impact of the CPI announcement on different currency pairs and witness the change in volatility due to the news release. For that purpose, we have collected the CPI ranking of Japan, where the below image shows Japan’s corruption score and rank in 2019. A score above 50 indicates low corruption levels and that the country’s government is clean.

USD/JPY | Before the announcement

Let us start our analysis with the USD/JPY currency pair and analyze the reaction of the market. The above image shows the daily time frame chart of the forex pair before the news announcement, where we see that the market is moving in a ‘range’ with the price at the top of the range. We will look to take a ‘short’ trade once we get confirmation from the market.

USD/JPY | After the announcement

After the news announcement, volatility increases to the downside, and the price falls drastically. The market reacted positively to the news data, where we see that the Japanese Yen gains strength after the news release. As the corruption index score was positive, traders strengthened the currency, as indicated by the large bearish ‘news candle.

GBP/JPY | Before the announcement

GBP/JPY | After the announcement

The above images represent the GBP/JPY currency pair, where we see that before the announcement, the market is in a strong uptrend, and recently the market has shown signs of reversal. We should be looking to sell the currency pair if the market is not able to move higher. However, we should wait for the news release to get a clear idea of the direction of the market.

After the news announcement, the market reacts similarly as in the previous currency pair, where the price moves lower and volatility expands to the downside. As the CPI data came out to be positive, traders sold British Pound and bought Japanese Yen, thereby strengthening the currency. At this moment, one can take risk-free ‘short’ trade with a stop loss above the ‘news candle.’

AUD/JPY | Before the announcement

AUD/JPY | After the announcement

Lastly, we will find out the impact on the AUD/JPY currency pair. The first image shows the characteristic of the chart before the news announcement, where it appears that the price is moving in a channel. One needs to be cautious before taking a ‘short’ trade as the price is at the bottom of the channel.

After the news announcement, the market gets a little volatile where we see that the price moves in both directions and finally closes near the opening. The overall reaction was bullish for the currency due to the healthy CPI data. The ‘news candle’ is not enough to confirm that the market is going lower as it has lower wick on the bottom, indicating buying pressure.

We hope you understood what ‘Corruption Index’ is and the impact on the Forex market after its news announcement. Cheers!