Morgan Stanley has recently coined the term the ‘Fragile Five’ which alludes to those troubled emerging market currencies of Brazil, South Africa, India, Turkey and Indonesia. Not only have their currencies been of concern but also rising inflation, weak growth and sizeable current account deficits.
Why the currency problem in emerging markets?
In the latter part of 2013 the then US Federal Reserve Chairman Ben Bernanke signaled that there would be a scaling back or ‘tapering off’ of its quantitative easing programme. Beginning in January 2014, the Fed would buy $75 billion in bonds each month, down from the $85 billion it had been buying since September 2012. Over the last couple of years QE has kept interest rates low forcing investors to look further afield to seek out the best return. Emerging markets attracted a lot of this capital and this had the effect of appreciating the local currency. With the tapering of bond purchases by the Fed and the improvement in the US economy, interest rates will begin to rise again which will attract capital back into the US and out of emerging markets. This is predictable but will the extent of this outflow of capital intensify into an emerging market currency crisis?
The central banks of Brazil, India, Indonesia, South Africa and Turkey have been busy hiking rates to counter plunging currencies. But currency depreciation has been a policy that many countries have pursued to boost growth in their economies – the weaker currency makes imports more expensive and exports cheaper. However the higher inflation that is generated by a weaker currency will diminish competitiveness sooner or later again.
The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.