Emerging markets' currencies are falling like a domino

A commodity curse? What is sure is that the "tigers", i.e. those countries that achieved an impressive economic expansion by exporting their natural resources, are capitulating to a whirl of global forces. China's move to devaluate the renminbi by 4.4% this week was the last blow in a downward process that is hitting hard currencies, capital flows and the economies of countries like Russia, Indonesia, Brazil alongside India, Turkey, Nigeria and South Africa, to name a few.

REUTERS/Olivia Harris.

These countries grew strongly since the early 2000s thanks to the high prices of oil, iron ore, steel and other resources that fueled ever stronger currencies as well.

The continuous decline over the last year in the demand for commodities due to a sluggish global growth, and lately waning demand in the world’s leading consumer of raw materials caused commodity prices to crater to their lowest levels since 1999, in other words, their lowest level in the 21st century.

This led to a blood bath for these countries' currencies in the last 12 months. The ruble shed 50% of its value, the Indonesian rupiah 54%; the South Korean won 34%, the Brazilian real 30%. Also the Mexican peso, whose underlying economy grew faster than expected, was drawn down.by 16%.

Currency slumps have dire consequences, even if a falling currency implies lower prices of its exports, theoretically increasing economic growth and employment, while it limits imports that have higher costs.

Firstly, the current "total carnage in commodity currencies”, as Piotr Matys, an emerging markets analyst put it speaking to the WSJ, is hitting countries that are already enduring the consequences of stubbornly high inflation rates, making things worse. Such is the case of Brazil, where inflation hovers over the 9.5% mark. To combat it the central bank is rising rates, but this increases the cost of business, the last thing a government wants to do in a recession with the prices of oil and other exports plummeting.

Secondly, a vulnerable currency takes a toll on the country's reserves when it comes to meet higher external debt payment obligations (which are denominated in a rising US dollar in the current crisis). This is what triggered the 1997-1998 Asian financial crises. Also private debt rises weighing on the economy.

Thirdly, international investors lose confidence, and pull capital out of the country, adding yet more downward pressure on the currency, and setting off a balance of payments crisis. The $1 trillion capital outflow from emerging markets in the last 13 months is no accident.

Currencies are falling like a domino. This week it was the turn of the tenge. Kazakhstan has been often trumpeted as the success model for a post-Soviet state transitioning to a dynamic market economy able to attract foreign investment, develop its infrastructure, and grow steadily. It holds oil reserves almost as large as the US's, with a population of just 17 million. Oil accounts for 55% of exports. On Tuesday, in order to compete with the declining currencies of its two main trading partners, Russia and China, the central bank decided to let the tenge float. On that very session the Kazak currency lost almost 25% against the dollar.

The rest of Kazakhstan’s economy is heavily dependent on neighboring Russia, whose economy contracted only in the second quarter by 4.6%. The degree of stress this commodity-driven economy is enduring shows in the collapse of the Russian ruble: 50% in one year. One of the hardest hit currencies, the plummeting ruble tipped the Kazakh domino over.

In Indonesia, where inflation surged to 8.6% in July, the central bank raised interest rates, adding to the pain of the country's finances, whose international reserves are at their lowest level since 2009. Nonetheless, to stop capital from fleeing, and the free fall of the rupiah, Giakarta did not have other options after the Finance Minister Chatib Basri said the country was not contemplating capital controls.

The massive loss of almost 30% in value of the Malaysian ringgit is causing nightmares to Malaysian businesses and to whoever buys products or services in hard currencies.

The Indian rupee slumped by 25 percent so far this year. In Africa, Nigeria, another big commodity exporter, has its central bank fending off speculative attacks on its currency.

The list of currency woes stretches across continents, and the more emerging market currencies lose value, the more concern there is about their health. Institutions like the IMF reckoned a slowdown of growth in emerging markets and developing economies, shaving their forecast for 2015 to 4.2% from 4.6% in the previous year.

So, which policies can emerging market's governments and central banks implement to stop the bleeding? Or is it rather, as Stephen King of HSBC economist warned back in May, that “The world economy is sailing across the ocean without any lifeboats to use in case of emergency?”

There is consensus among experts that if emerging markets' central banks went like Draghi, saying that they would do "whatever it takes" to defend their currencies by providing liquidity, the relief would only be short-lived, and the cost too high. Bigger rate hikes would go further towards stabilizing currencies, but policymakers, considering external factors such as oil sliding to $30 a barrel will likely continue to be restrained by the desire to prevent growth from slowing farther or too sharply.

To be sure, policymakers have a role to play to avoid the problems for which investors are increasingly unforgiving, whether it's corruption in Brazil, populist ruinously social policies in Venezuela, geopolitical instability in Turkey, sanctions defiance in Russia, and so on.. A scenario is shaping where the flow of cheap dollars from the US dries up (when the Federal Reserve starts hiking rates for the first time in 6 years), and demand for commodities and growth continues to be sluggish. As billionaire Warren Buffett's dictum        goes: "it's only when the tide goes out that you learn who's been swimming naked". However, in a world with ever more interconnected national and regional economies it is in everybody's interest that no country is left behind in that condition.

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