The two-day sell-off of currencies
and shares of several developing countries last week raises the question
of whether this is the start of a new financial crisis.
The sell-off in emerging economies also spilled over to the American and European stock markets, thus causing global turmoil.
Malaysia was not among the most badly affected, but the ringgit also declined in line with the trend by 1.1% against the US dollar last week; it has fallen 1.7% so far this year.
An American market analyst termed it an “emerging market flu”, and several global media reports tend to focus on weaknesses in individual developing countries.
However, the across-the-board sell-off is a general response to the “tapering” of purchase of bonds by the US Federal Reserve, marking the slowdown of its easy-money policy that has been pumping billions of dollars into the banking system.
A lot of that was moved by investors into the emerging economies in search of higher yields. Now that the party is over (or at least winding down), the massive inflows of funds are slowing down or even stopping in some developing countries.
The current “emerging markets sell-off” is thus not explained by ad hoc events. It is a predictable and even inevitable part of a boom-bust cycle in capital flows to and from the developing countries, coming from the monetary policies of developed countries and the investment behaviour of their investment funds.
This cycle, which is very destabilising to the developing economies, has been facilitated by the deregulation of financial markets and the liberalisation of capital flows, which in the past was carefully regulated.
This prompted bouts of speculative international flows by investment funds. Emerging economies, having higher economic growth and interest rates, attracted investors.
Yilmaz Akyuz, chief economist at South Centre, analysed the most recent boom-bust cycles in his paper Waving or Drowning?
A boom of private capital flows to developing countries began in the early 2000 but ended with the flight to safety triggered by the Lehman collapse in September 2008.
The flows recovered quickly. By 2010-12, net flows to Asia and Latin America exceeded the peaks reached before the crisis. This was largely due to the easy-money policies and near zero interest rates in the United States and Europe.
In the United States, the Fed pumped US$85bil (RM283bil) a month into the banking system by buying bonds. It was hoped the banks would lend this to businesses to generate recovery, but investors placed much of the funds in stock markets and developing countries.
The surge in capital inflows led to a strong recovery in currency, equity and bond markets of major developing countries. Some of these countries welcomed the new capital inflows and boom in asset prices.
Others were angry that the inflows caused their currencies to appreciate (making their exports less competitive) and that the ultra-easy monetary policies of developed countries were part of a “currency war” to make the latter more competitive.
In 2013, capital inflows into developing countries weakened due to the European crisis and the prospect of the US Fed “tapering” or reducing its monthly bond purchases.
This weakening took place just as many of the emerging economies saw their current account deficits widen. Thus, their need for foreign capital increased just as inflows became weaker and unstable.
In May to June 2013, the Fed announced it could soon start “tapering”. This led to sudden sharp currency falls, including in India and Indonesia.
However, the Fed postponed the taper, giving some breathing space. In December, it finally announced the tapering — a reduction of its monthly bond purchase from US$85bil (RM283bil) to US$75bil (RM249bil), with more to come.
There was then no sudden sell-off in emerging economies, as the markets had already anticipated it and the Fed also announced that interest rates would be kept at current low levels until the end of 2015.
By now, however, the investment mood had already turned against the emerging economies. Many were now termed “fragile”, especially those with current account deficits and dependent on capital inflows.
Most of the so-called Fragile Five are in fact members of the BRICS, which had been viewed just a few years before as the most influential global growth drivers.
Several factors emerged last week, which together constituted a trigger for the sell-off. These were a “flash” report indicating contraction of manufacturing in China; a sudden fall in the Argentinian peso; and expectations that a US Fed meeting on Jan 29 will announce another instalment of tapering.
For two days (Jan 23 and 24), the currencies and stock markets of several developing countries were in turmoil, which spilled over to the US and European stock markets.
If this situation continues this week, it may just signal a new phase of investor disenchantment with emerging economies, reduced capital inflows or even outflows. This could put strains on the affected countries’ foreign reserves and weaken their balance of payments.
The accompanying fall in currency would have positive effects on export competitiveness, but negative effects on accelerating inflation (as import prices go up) and debt servicing (as more local currency is needed to repay the same amount of debt denominated in foreign currency).
This week will thus be critical in seeing whether the situation deteriorates or stabilises, which may just happen if the Fed decides to discontinue tapering for now. Unfortunately, the former is more likely.
> The views expressed are entirely the writer’s own.
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The global economic expansion is speeding up, data this week are projected to show. In the U.S., a gain in fourth-quarter gross domestic product probably completed the strongest six months of growth in almost two years for the world’s largest economy. The pickup combined with progress in the labor market means Federal Reserve policy makers meeting this week may ease up again on the monetary accelerator.
Across the Atlantic, the U.K. economy may have grown over the past 12 months by the most in almost six years, while in Germany, business confidence probably improved to the highest level since mid-2011.
This week also includes central bank meetings in Mexico and New Zealand. In Mexico, monetary officials may keep the benchmark interest rate unchanged as more government spending reduces the need for stimulus. Such a decision is less clear in New Zealand, where odds of an interest-rate increase have climbed.
U.S. ECONOMY
-- Gross domestic product advanced at a 3.2 percent annualized rate in the fourth quarter as spending by American consumers climbed by the most in three years, economists forecast the Jan. 30 figures will show. Combined with a 4.1 percent inventory-fueled gain in the prior period, GDP in the second half of the year was the strongest since the six months ended March 2012.-- “A substantial acceleration in private sector demand led by stronger consumer spending and a significant pickup in exports after weakness through the first part of the year should drive a second straight quarter of near 4 percent real GDP growth even with an expected drag of 0.5 percentage point from federal government spending, largely reflecting lost work hours during the government shutdown,” Ted Wieseman, an economist at Morgan Stanley in New York, wrote in a Jan. 17 report.
-- “The first cut of Q4 GDP will be more about the internals of the report than the headline,” economists at RBC Capital Markets LLC, led by Tom Porcelli, wrote in a research note. “While we look for a 2.8 percent annualized advance in top-line growth, the details should seem even brighter with real personal consumer consumption rising 4 percent. We anticipate that the inventory swing will hold growth back a full percentage point.”
FOMC MEETING
-- Ben S. Bernanke will chair his final meeting of Federal Reserve policy makers on Jan. 28-29 before handing over the reins of the world’s most powerful central bank to Janet Yellen. Bernanke and a different cast of regional Fed bank presidents who’ll vote on the Federal Open Market Committee are projected to reduce the pace of Treasury and mortgage-backed securities purchases by a total of $10 billion to $65 billion as the economy improves.-- “We expect the Fed to announce another $10 billion taper and possibly strengthen its guidance,” Michael Hanson, U.S. senior economist at Bank of America Corp., said in a research note. “The Yellen-led Fed will see numerous personnel changes in 2014, but we still expect a patient and very accommodative policy stance.”
-- “The FOMC will likely upgrade its summary of current economic conditions in its policy statement,” BNP Paribas’ Julia Coronado, a former Fed Board economist, said in a research note. “The Q4 performance is expected to be driven by final demand, in particular a surge in consumer spending on goods and services. The January FOMC statement could acknowledge this better performance by stating that ‘economic growth picked up somewhat’ of late.
‘‘The confirmation of their long-held optimistic expectation for stronger economic growth and tranquil financial markets will likely lead the Committee to announce another ‘measured step’ in the tapering process. We expect another $10 billion cut in the pace of QE asset purchases.’’
U.K. ECONOMY
-- Britain will be the first Group of Seven nation to report gross domestic product for the fourth quarter when it releases the data on Jan. 28. Economists forecast growth of 0.7 percent, close to the 0.8 percent expansion in the prior three-month period. From a year earlier, GDP probably rose 2.8 percent, driven by domestic demand, which would be the best performance since the first three months of 2008.-- ‘‘To date, the recovery has been somewhat unbalanced, led by consumption, so we remain skeptical about the sustainability over the medium-term,’’ said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. ‘‘Still, there is clearly sufficient momentum in the short-term data to underpin trend-like rates of growth.’’ Walker sees the economy expanding 2.7 percent this year, just above the Bloomberg consensus estimate of 2.6 percent.
GERMAN BUSINESS CONFIDENCE
-- German business confidence is heading for its highest reading in 2 1/2 years, underlining the strength in an economy that’s helping to power the euro-area recovery. Economists in a survey, set for release on Jan. 27, see the business climate index increasing to 110 in January from 109.5 last month. Germany will continue to outpace the euro area this year, with the International Monetary Fund forecasting 1.6 percent expansion, compared with 1 percent for the currency region.-- Thilo Heidrich, an economist at Deutsche Postbank AG in Bonn, said the ‘‘mood in the German economy is likely to have brightened at the start of the year.’’
-- ‘‘The near-term outlook remains one of cautious optimism,’’ Bank of America economists including Laurence Boone said in a note. ‘‘Domestic demand, in particular, should support growth in coming years.’’
JAPAN TRADE
-- Japan’s trade deficit narrowed to 1.24 trillion yen ($12.1 billion) in December from a month earlier, even as import growth probably accelerated, according to a Bloomberg survey of economists before data due Jan. 27. A record run of monthly deficits shows the cost of the yen’s slide against the dollar and the extra energy imports needed because of the nuclear industry shutdown that followed a disaster in 2011.-- ‘‘Throughout the year, few manufacturers believed that the yen would stay weak, let alone depreciate further,” Frederic Neumann, Hong Kong-based co-head of Asian economics at HSBC Holdings Plc, said in a research report. “As a result, (dollar) prices charged for goods sold overseas were not cut amid fears that such a move would have to be reversed once the currency strengthened again, something that few firms like to do. All this meant nice profits for Japanese firms (higher yen earnings for their shipments) but no gain in export market shares.”
NEW ZEALAND RATES
-- Economists and markets are split on whether the Reserve Bank of New Zealand will increase the official cash rate for the first time in 3 1/2 years at its Jan. 30 meeting. Governor Graeme Wheeler said late last year the RBNZ will need to raise interest rates in 2014 as growth and inflation accelerate and unemployment declines. While only three of 15 economists predict Wheeler will lift the rate by 25 basis points to 2.75 percent this week, markets are pricing in an almost 70 percent chance he will do so.-- “The lists of reasons are long for both the ‘why wait’ and ‘why not’ sides of the fence,” Nick Tuffley, chief economist at ASB Bank Ltd. in Auckland, said in a research report. “The RBNZ can justify either outcome, and we put the chances of a rate hike as 1 in 4. That is to say, not our core view, but a significant risk.”
MEXICO RATE DECISION
-- Mexico’s central bank on Jan. 31 may keep the overnight interest rate unchanged at a record-low 3.5 percent in its first decision of 2014 as increased government spending stimulates the economy.-- “There’s no need to reduce the rate any more” after 0.25 percentage-point reductions in September and October, Marco Oviedo, chief Mexico economist at Barclays Plc, said in an e-mailed response to questions. “The economy has shown signs of recovery.”
-- Policy makers have “sent the message that they’re comfortable with the current level of interest rates,” said Gabriel Lozano, chief Mexico economist at JPMorgan Chase & Co. With sales tax increases fanning inflation, “real interest rates are temporarily negative, but the central bank will be confident this is a transitory situation that will correct in the second half of the year” as inflation slows.
Contributed b Bloomberg
