September 18, 2013

Breathing Room for Emerging Markets Watching Money Flee


JAKARTA, IndonesiaWhen the Asian financial crisis hit in 1997, sales plummeted 95 percent and stayed down for six months at the IGP Group, Indonesia’s dominant manufacturer of car and truck axles. Four-fifths of the company’s workers lost their jobs.

When the global financial crisis began in 2008, IGP’s sales briefly dropped nearly one-third, and a quarter of the employees were put out of work.

The latest downturn, which began in early August, has been much more modest. IGP’s axle shipments are down 10 percent in the last month from a year ago. The company’s work force has barely shrunk, to 2,000 from 2,077 at the end of July, though IGP plans to reach 1,900 by the end of this year.

“These are challenging times, but I don’t think they will be the same as in 2008 or 1998,” Kusharijono, IGP’s operations director, who uses only one name, yelled over a clanking, cream-colored assembly line here for minivan rear axles.

From Indonesia and India to Turkey and Brazil, capital flight from developing economies to the United States is already causing hardship for millions of businesses and workers. More was expected if the Federal Reserve decided to retreat from its economic stimulus campaign of buying billions of dollars in bonds each month.

That it decided on Wednesday not to stop may relieve some companies, government leaders and economists who worried that rising interest rates in the United States would draw tens of billions of dollars out of emerging markets and cause local currencies to fall further against the dollar.

Investors have been moving money into dollar-based investments that offer higher yields.

But the Fed’s announcement Wednesday afternoon took currency traders by surprise, and the dollar plunged against major currencies. The dollar fell a little more than 1 percent against the euro and the yen after the announcement, giving companies in the developing economies a little more breathing room. On Thursday, currencies in Thailand, Indonesia, the Philippines and Malaysia, which have fallen sharply in recent months, headed higher, with the Indonesian rupiah gaining about 1.5 percent against the dollar by late morning in Asia.

The economic slowdowns in the developing economies seem less severe so far than in other recent downturns. While previous exoduses by investors from volatile emerging markets have caused waves of bank failures, corporate bankruptcies and mass layoffs, the latest retrenchment has been much milder so far. That partly reflects the belief that when the Fed does move, it will scale back its bond purchases very gradually, business leaders and economists around the world said in interviews this week. The effects have also been limited partly because banks, companies and their regulators in many emerging markets have become much more careful about borrowing in dollars over the last two decades, except when they expect dollar revenue with which to repay these debts.

In 1997 and 1998, “the whole problem began with the banking sector. Now I think the banking sector is much better,” said Sofjan Wanandi, a tycoon who is the chairman of the Indonesian Employers’ Association and part owner of IGP.

Trading in currency and stock markets seems to suggest that some of the worst fears over the summer are starting to recede. The Brazilian real has recovered about 8 percent of its value against the dollar since Aug. 21 and a little over a third of its losses since the start of May, when worries began to spread about the vulnerability of emerging markets to a tightening of monetary policy. Stock markets from India to South Africa have rallied from lows in late August, with Johannesburg’s market up 14.7 percent since late June after a swoon earlier than most emerging markets.

While the Fed hasn’t started the tapering process as yet, there has been a considerable withdrawal of money in the emerging markets and especially in India since May. In my opinion, the major effect has already taken place,” said Sujan Hajra, the chief economist at AnandRathi, an investment bank based in Mumbai.

One lingering question is how much inflation will accelerate in emerging markets. Many of their industries depend heavily on commodities like oil that are priced in dollars.

Weakening exchange rates this year for almost every emerging market’s currency have made these dollar-denominated commodities more expensive. That is starting to drive up inflation in a few countries that do not subsidize fuel prices, and it is adding to government deficits in many countries, like India and Indonesia, that do.

In Brazil, an increase in transportation fares set off street protests in June, leading to broad demonstrations over corruption and lamentable public services. Salomão Quadros, an economist at Fundação Getulio Vargas, a top Brazilian university, said inflation was expected to reach about 6 percent this year as imported goods become more expensive.

While that level exceeds the central bank’s inflation target of 4.5 percent, inflation in Brazil still remains much lower than it has been in other stretches of market turbulence, as in 2003, when inflation rose to about 15 percent. Brazil is facing some difficulties, but we’re not in crisis territory,” Mr. Quadros said.

The most vulnerable companies are those that mostly sell domestically in their local currency but have debts or costs denominated heavily in dollars. One example is the plastics industry, which often relies on imported resins made to a large extent from high-priced oil.

Ahmet Nalincioglu, the managing director of Elektroplasmin, a plastic packaging company based in Istanbul, said many plastics producers would have to try to raise prices. Yet Elektroplasmin has yearlong contracts with clients that are hard to change.

“Our price hikes will automatically have a negative impact on their profit margins, which means they will be reluctant to negotiate,” Mr. Nalincioglu said. “If I can’t agree on a price, I get stuck with the stock for a year and suffer huge losses.”

The most vulnerable countries are those running large trade deficits they have been financing with dollars from overseas investors’ purchases of local assets like real estate, stocks and bonds. India is conspicuous on that list, as its poor roads and stifling bureaucracy have discouraged exports and resulted in its luring few of the factories now moving out of China in response to surging wages there.

A few emerging markets, still traumatized by the extent of their economic downturns during previous periods of capital flight, are taking drastic action to stabilize their currencies. Indonesia had one of the few emerging market currencies that was still falling through last week, but the central bank stopped the drop last Thursday when it unexpectedly raised its two benchmark interest rates by a quarter percent.

The interest rate increase made it more attractive for international investors to lend money to Indonesia, but at the risk of further weakening a domestic economy that is already decelerating.

Didik Rachbini, one of the 21 members of the presidential National Economic Council here, said the Indonesian government was also discussing delays in big investment projects by state-owned enterprises, to conserve foreign exchange. Work like road construction that requires few imports of equipment is likely to proceed, while capital-intensive projects that rely on foreign technology should face extra scrutiny and are starting to be reviewed, he said.

Most affected by the economic slowdown are workers in developing countries who were already scrimping. Hasan Qodri, a 22-year-old axle quality inspector at Indonesia’s IGP, said he regretted the disappearance of overtime — and the extra pay that went with it.

Of course I would like more overtime,” he said, “so I’d have more money for my daily life.”

Keith Bradsher reported from Jakarta, Simon Romero from Rio de Janeiro and Ceylan Yeginsu from Istanbul. Neha Thirani Bagri contributed reporting from Mumbai.

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