Investors’ fears that the U.S. Federal Reserve is preparing to end its monetary stimulus is taking a heavy toll on emerging market currencies. Over the past six months, only China’s carefully managed yuan has held its ground against the dollar. Investors believe that the tide of money unleashed by the U.S. Federal Reserve and that has flooded into emerging markets — an estimated $3.9 trillion of it over the past four years — will now rapidly ebb.
They are shunning markets now seen as riskier because of funding deficits, slowing economies and inflation in favor of the nascent recoveries in the developed economies. On August 19, the 20 biggest emerging market currencies all tumbled against the dollar, with India’s rupee suffering worst. It hit another low at 63.2 to the dollar — a 12% depreciation against the U.S. currency so far this year.
Only the Brazilian real and South Africa’s rand have recorded bigger declines in 2013. Countries with current-account deficits — India, Brazil and South Africa have three of the four largest among emerging economies — are particularly vulnerable. Investors, with some justification, see those deficits as now being plugged by highly mobile hot-money inflows more than stable foreign direct investment. It is not coincidence that international investors have increasingly questioned the competence of the economic management of the governments in all three countries.
Those concerns play quickly through to equity markets, too. In Indonesia — the fourth of the big-deficit quartet — the main stock index fell 5.6% on August 19 following a report from the central bank saying the country’s current account deficit had widened sharply in the second quarter.
The fear is that the retreat will turn into the sort of rout that was seen in the 1997 Asian financial crisis, when Thailand’s currency halved in six months and currency contagion swept through the region like an epidemic. We are far from that, at least for now. For one, banking systems are more robust and foreign-exchange regimes more flexible in emerging economies than they were then. Countries such as Thailand, South Korea, Japan and Indonesia all made structural reforms to their financial and economic systems in the aftermath particularly by way of cleaning up the banking system and freeing capital markets from implicit and explicit controls. This was one of the most important consequences of the crisis.
One measure of the shifting of capital flows now going on is that almost $95 billion has been poured into exchange-traded funds (ETFs) of U.S. shares for this this year, while developing-nation ETFs have seen withdrawals of $8.4 billion, according to data compiled by Bloomberg. That is not just the effect of potential quantitative tightening. For emerging nations like India, Brazil and South Africa it is also part of the price of failing to carry out vigorously enough long-overdue structural changes to their economies.