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By HaleStewart January 30, 2014 2:57 pm
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A Review Of Recent Extraordinary Emerging Market Central Bank Activity

Starting at the end of last week, emerging market currencies sold off sharply, along with developed market equities.  The primary cause of this sell-off was concern that China was in fact slowing down.  Since most emerging markets sell raw materials to China, China’s slowdown would have a negative impact on their respective GDPs.  In addition, with the US Federal Reserve finally tapering its asset purchase program, money was flowing back from emerging markets to the US, UK and EU.  To limit the impact of these respective currency drops, we’ve had a number of very important central bank actions.

India raised its interest rate by 25 basis points, increasing the rate from 7.75% to 8%.  One of India’s biggest problems is inflation.  While the latest reading showed a decrease, it was still printing at a 6.16% annual rate of change.  And, the overall inflation rate is still elevated.

In addition, India has structural issues to deal with – issues that are hurt by the capital flight currently taking place.  The budget deficit is 5.3% of GDP while the current account is 4.6% -- and still growing.  Although the country is currently experiencing weaker than desired growth, the central bank has clearly determined that inflation and fighting the structural problems is much more important.

The sharpest increase rate increase came from Turkey:

The Ankara-based bank increased the one-week repurchase rate to 10 percent from 4.5 percent, while lifting the overnight lending rate to 12 percent from 7.75 percent and the overnight borrowing rate to 8 percent from 3.5 percent.

The Lira has been under attack for some time, largely in reaction to internal political issues.  However, the sharp nature of the Lira’s drop prompted the Turkish central bank into an emergency session earlier this week.

In addition to the polical issues, Turkey has some fairly serious structural problems.  Their trade deficit is 6% of GDP and the government budget deficit is a little over 2%.  In addition, unemployment -- whilel stable for the last few years -- is still over 9%. 

Russia is also taking efforts to defend the ruble against its slide against the dollar:

The Bank of Russia shifted the ruble's trading band higher Monday for the ninth time so far in 2014, in response to continuing selling pressure on the Russian currency, which hit a fresh five-year low.

The central bank said on its website that it moved the ruble's floating trading band 5 kopecks higher to RUB33.50- RUB40.50 against the euro-dollar basket, which is the central bank's main gauge of the currency market.

Russia has low government debt and a positive trade balance.  But they have tremendous structural problems.

Finally, we have South Africa, which raised its rates 50 basis points (to 5.5%) on Friday.

When looking at the above actions it’s important to remember that central banks don’t like surprises; they see themselves as the calm, cool players in the economy.  When circumstances force them to act, it’s usually a sign there is a big problem either developed or which has developed that is literally forcing their respective policy hands.

At the same time, it’s important to remember that the possibility of “contagion” – the effects of one downward trading currency bleeding into other markets – is low.  All of the above countries have country specific issues to deal with.  Russia and Brazil both had raw materials to export to China when China was building literally everything on the planet.  But as China moves to an economy driven more by internal demand, these two countries are losing some of their export market.  South Africa is in the same Russia benefitted from having oil reserves to export.  But, they’ve never fundamentally reformed their economy.  And Turkey has internal political issues to deal with.  But note that all of the above are country specific and don’t point to region wide problems.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer





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