Syria today, the taper tomorrow — emerging market policymakers are learning that once the market becomes concerned with a current account deficit, most news is bad news.
Having enjoyed easy funding and massive inflows for much of the post-financial crisis period, the prospect of structurally higher global interest rates has made the world suddenly a much less welcoming place for emerging markets. Expectations that a US-led military strike against Syria would cause oil to spike in cost, driving up current account deficits for non-oil-producing countries, helped spur the latest weakness.
And any bit of good US economic news, bringing with it higher chances of a Federal Reserve cutback on bond purchases, have only made it worse.
That’s especially true for those, like India, South Africa and Brazil, that import more than they send abroad and thus must rely on foreign money to fund borrowing needs.
When money was easy and investors entranced by stories of structurally superior growth, those funding needs were easily and cheaply met. Now, not so much, and emerging market currencies have been tumbling and flows of funds reversing rapidly. “The last few weeks have conclusively demonstrated the idiocy of one of the key investment themes since the 2008 Great Recession — namely that with developed economies burdened with excessive debt and in the throes of multi-year deleveraging, investing in emerging markets would not only produce superior returns but was also less risky,” wrote Albert Edwards, a global strategist at Societe Generale, in a note to clients.
“Regular readers will know we have long railed against this idea, having dubbed the BRIC story a Bloody Ridiculous Investment Concept.”
With an extended sell-off under way, emerging market central banks are making apparently frantic efforts to buy stability. The Reserve Bank of India engineered a bounce in the hard-hit rupee from recent all-time lows, unveiling a deal whereby it would provide dollars directly to state-run oil companies, which use them to purchase oil abroad.
The Brazilian central bank hiked rates yet again, this time by half a percentage point, to nine per cent, its fourth hike in four meetings. Bank Indonesia also hiked by half a percent in a relatively rare inter-meeting move, taking benchmark rates to seven per cent.
India particularly showed a note of panic in its attempts to counteract the 20 per cent fall in the rupee. Having unveiled a host of other measures to support the rupee, India is mulling a scheme to have banks buy gold from households.
As with oil, India is a big consumer but not a producer of gold, and must send dollars abroad to bring it home. The idea would be to persuade households, many of which keep substantial wealth in gold, to part with it in exchange for rupees. The gold could then be smelted and reused domestically, thereby avoiding the need to send dollars abroad.
Sound desperate to you? The unfortunate reality is that current account deficits are easy to tolerate when times are good, but very difficult and painful to fix quickly if the market, as it appears to be doing, loses patience.
“The only lasting solution to our external sector problem is to reduce the CAD (current account deficit) to its sustainable level,” outgoing Reserve Bank of India (RBI) hovernor Duvvari Subbarao said. “Reducing the CAD requires structural solutions. RBI has very little policy space or instruments to deliver the needed structural solution. They fall within the ambit of the government.”
Interestingly, China thus far has been a strong out-performer, with Shanghai stocks doing well and investors apparently no longer that concerned by the cash crunch of earlier this summer.
Edwards, a well-known bear of long standing, notes that Chinese officials, having bemoaned quantitative easing (QE) when it was being expanded, are now doing the same as it threatens to contract. Indeed, credit growth, on which China is highly dependent, has been falling.
Edwards argues that Chinese officials may in the end choose to devalue the yuan as a way to expand credit. That would be very deflationary for the rest of the world, and doubtless highly destabilising for financial markets.
Markets, especially currency markets, tend to fasten on to themes, usually until they overshoot. As we’ve seen several times in the past, that seldom ends quietly for emerging markets and current account deficits.
