Just when we were all being lulled into thinking that the global economy was on the mend, trouble has broken out yet again. This time, it’s in emerging markets. Since the beginning of the year the currencies of Turkey, Argentina, Brazil, South Africa, Russia, Hungary, Indonesia, Chile and others have fallen sharply. Several countries have raised interest rates to try and stabilise markets.
This latest financial unrest has undermined global equity markets, and raised concerns about spillovers into the West. Problems in Turkey could affect Greece and Cyprus. Problems in South America could reflect on Spanish banks. Higher interest rates in emerging countries could add to the deflationary pressures already coming from weak global demand, and liquidity tightening in the US and China.
While vigilant about these things, there is a sharp difference of opinion between those who believe the current emerging market currency unrest is momentary and manageable, and those who see it as a darker harbinger of more serious problems in precisely those countries that are supposed to be the beacon of global economic growth in the world. After all, emerging markets now comprise about 40% of global output, and over 50%, depending on choice of measurement. They have recently contributed three quarters of global growth, though that proportion will be markedly lower in 2014-15 as the growth pendulum shifts westwards. So, storm in a teacup, or proper storm?
Caught in US-China crosshairs, but more than that
Emerging markets are caught in the crosshairs of important shifts in interest rate and liquidity trends in both the US and China. In the US, the Federal Reserve announced in December that it would commence ‘tapering’ (or slowly scaling back the purchase of assets under the programme of QE) from January 2014. The concern here is that rising US bond yields will attract back the capital that flowed into emerging markets in the wake of QE. A recent study by the World Bank (Global Economic Prospects, January 2014) estimated that US interest rates, QE and other external factors accounted for 60% of the increase in capital flows to emerging countries between 2009-13, with domestic factors accounting for the remainder. Investors are also anxious that the tapering decision, itself, is a stepping stone eventually to higher policy rates too.
In China, interest rates have been rising too, though further away from the glare of the world’s financial media. As China’s authorities…