EMERGING MARKETS ENDURE WILD ROLLERCOASTER RIDE / THE FINANCIAL TIMES

22, 2013 8:53 pm

 

Emerging markets endure wild rollercoaster ride

 

By Robin Wigglesworth and Claire Jones

 

 

Thursday was another day of turmoil for emerging markets.

 

Unimpressed by the Turkish central bank’s recent efforts to support its currency, investors sent the lira down to a record low against the US dollar; India’s rupee fell to its lowest-ever level; Indonesia’s rupiah dropped to the weakest since 2009.

Central bank reserves

 

As if that were not enough, Malaysia’s ringgit and Thailand’s baht ended the day in a three-year trough.

 

Many central banks have sought to reverse or at least slow the declines by using foreign currency reserves to intervene in the markets. Morgan Stanley estimates that central banks in the developing world, excluding China, lost about 2 per cent of their reserves between May and July.

 

The decline in reserves is driven both by simple outflows of foreign capital and by market interventions.
 
The US Federal Res­erve’s plan to reduce its monetary stimulus has spooked investors and driven many to pull money out of the developing world, sending most emerging market currencies tumbling.
 
Although reserves are held precisely for these sorts of squalls, the pace and extent of the declines have been particularly eye-catching in some countries.
 
Indonesia has lost 13.6 per cent of central bank reserves, Turkey 12.7 per cent and Ukraine almost 10 per cent. But India and Brazil, two other countries with struggling currencies, have lost a more moderate 5.5 and 1.8 per cent respectively.
 
While depreciating currencies make exports cheaper, they also fuel inflation by increasing the cost of imports. And many emerging market companies, governments and households have loans denominated in dollars or other foreign currencies that become pricier to pay off if the domestic currency is in the doldrums.
 
While most emerging markets no longer have heavily managed or pegged exchange rates, central banks nonetheless occasionally intervene in currency markets to prevent depreciations or appreciations becoming too volatile.
 
But the overall decline in reserves stands in sharp contrast to a long trend of healthy and climbing financial firepower in the developing world, driven both by trade surpluses and prudence following past crises in the 1980s and 1990s.
 
A series of financial calamities triggered a seismic shift in thinking among emerging market policy makers: higher reserves to prevent any more humiliating western bailouts.
 

The accumulation of reserves has gathered pace since the start of the financial turmoil, when capital inflows into emerging markets swelled because of western monetary stimulus and investor aversion to the stricken “advanced” economies. By the end of the first quarter of 2013, emerging market central banks held $7.4tn of foreign currency reserves, according to International Monetary Fund Cofer data.

 

While this trend is reversing, emerging market veterans point out that central banks’ war chests are still much larger than they have been in past crises. Exchange rates are now for the most part flexible, and governments no longer rely as much on foreign funding.
 
All these structural improvements should serve emerging markets well in a less easy monetary policy environment. However, not all countries have accumulated reserves at the same pace. China and the oil-rich Gulf states represent a large chunk of the IMF’s estimates. Even relatively high reserves can be quickly depleted if a country has a large current account deficit.
 
While most developing country governments have weaned themselves off an addiction to foreign currency-denominated loans, many companies have gone on a dollar borrowing splurge. Many investors still see this as a big vulnerability. For that reason, investors expect many central banks to step away from direct currency market interventions and attempt to stanch outflows through interest rate increases. That may hurt growth, but many countries may have no choice.