Emerging markets: The perils of denial

Emerging markets: The perils of denial

Jan 24th 2014, 16:11 by Buttonwood

THE big sell-off in emerging market currencies yesterday is an odd example of “remembrance of things past”; one’s mind is drawn back to 1998, or even 1982 and the crises of old. Not that long ago, it was the developed economies that were causing all the problems and the emerging markets that seemed to offer hope; now the news out of the rich world is a lot more positive whereas the weaknesses of some developing countries are showing again.

Margaret Thatcher is not a popular heroine in Argentina but it is tempting to recall her aphorism that “you can’t buck the markets”. The country was running with an exchange rate that was (and still is) out of whack with the black market rate; its government was also quoting an inflation rate that was well below independent estimates of 23.4%. Defending the exchange rate required official intervention that was eating away at the country’s reserves. Yesterday, the authorities stopped intervening; today, they relaxed capital controls. While there was brave talk that a rate of 8 pesos to the dollar was fair value, the black market rate is more like 13. The scope for the official rate to fall dramatically is clear. The big question concerns the economic consequences of the devaluation; will this lead to a big rise in the cost of imported goods (pushing inflation up further and putting more downward pressure on the peso) or does the cost of private sector goods already reflect the black market rate?

The other case of denial was in Turkey, where it seems clear the central bank would have liked to raise rates this week, but was discouraged from doing so by the government. Turkey has a current account deficit of 7.5% of GDP and inflation of 7.5%; monetary tightening looks appropriate. (The central bank indicated that it may allow interbank rates to hit 9% on some days, but they are normally 7.75%, ie, barely positive in real terms). Again, a big fall in the lira will boost Turkish exporters but creates the peril of a further surge in the inflation rate. The Turks have intervened to support the lira but how long can they do that; at $33 billion, their reserves are only a little larger than Argentina’s.

The broader question is whether these sell-offs are just “little local difficulties” or are a herald of a 1997/1998-style collapse? It is worth remembering that most emerging economies are sounder than they were 16-17 years ago, in the sense that they tend to have smaller current account deficits and are less dependent on inflows of hot money. But they are not homogenous. The countries that are suffering now are those with the worst policies or the most obvious weaknesses. For the sector as a whole, China is the giant panda in the room; there are worries about an investment product that may default at the end of this month. By itself, this seems unlikely to provoke panic; its travails are down to a specific investment, rather than hinting at a more broad malaise, along the lines of subprime loans. The Economist’s man in HK is not too worried.

But the stories have certainly created a risk-off mood in the stockmarkets; they did enter 2014 in remarkably optimistic mood.