© The Financial Times Ltd 2015 FT and 'Financial Times' are trademarks of The Financial Times Ltd.
August 22, 2013 8:53 pm
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.
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.
Ukraine badly hit in EM turmoil
Ukraine has been one of the worst-hit emerging markets since talk of reducing US monetary policy began, writes Roman Olearchyk in Kiev.
Figures released this month showed that Ukraine’s central bank reserves, which have been declining for the past two years, shrank 7.4 per cent in the past year, to $22.7bn, the equivalent of just below 2.8 months of imports, and the lowest level since 2006.
The government is in a particularly difficult situation, having struggled for much of this year to contain trade and budget deficits. It is now facing additional pressure in the form of a trade stand-off that erupted last week with one of its main export markets, Russia.
It is still keen to negotiate a fresh $15bn loan from the International Monetary Fund to help reboot an economy that is struggling to crawl out of its second recession in five years.
Further declines in reserves are expected in the coming months as Ukraine’s government struggles to cover about $4bn in external debt payments, while containing trade and budget deficits, all while the central bank manages its currency.
“The slump in Ukrainian FX reserves . . . serves as a reminder that Ukraine’s fragile external position continues to keep it one step away from a full-blown balance of payments crisis,” London-based Capital Economics said in a July note.
Creditors, including the IMF, are increasingly alarmed amid concerns over whether Ukraine will be able to service its debt obligations. When emerging markets were flush with western central bank easy money-driven liquidity, Kiev managed to patch up state finances through domestic bond and eurobond issues. But with expectations building of US Federal Reserve tapering, the eurobond resource is becoming more expensive.
Analysts say that the advent of the taper will reduce Kiev’s ability to roll over debts through fresh eurobond issues, increasingly tilting the country towards a fresh IMF loan.
In comments emailed this week, an IMF spokesperson said: “There have been no in-depth discussions of such a comprehensive programme at the policy level since . . . April. We understand that the authorities are in the process of elaborating such a comprehensive programme and that they plan to present it soon.”
Please don't cut articles from FT.com and redistribute by email or post to the web.
Sign up for email briefings to stay up to date on topics you are interested in