Re­serves no guar­an­tee

Some emerg­ing mar­kets fight a los­ing bat­tle

Finweek English Edition - - Property Compass - GRETA STEYN

EMERG­ING MAR­KETS CAN BE for­given for feel­ing a lit­tle hard done by. De­spite ma­jor re­forms since pre­vi­ous crises, they’ve been hard hit by the global fi­nan­cial cri­sis em­a­nat­ing from the United States. Not even a buf­fer of for­eign ex­change re­serves has been enough to in­su­late some im­por­tant mar­kets against cur­rency weak­ness.

What must make emerg­ing mar­kets feel par­tic­u­larly sore is the amaz­ing strength of the US dol­lar. De­spite US banks tee­ter­ing on the brink of col­lapse, the US dol­lar has strength­ened from lev­els around US$1,60/€1 be­fore the cri­sis to around $1,25/€1.

Those with mem­o­ries of 1997/1998, when the south-east Asian cri­sis hit, will re­mem­ber those coun­tries’ banks were also in bad shape at the time. De­spite their bank­ing prob­lems their US-led lender – the In­ter­na­tional Mon­e­tary Fund – still forced them to raise in­ter­est rates. The US, fac­ing a cur­rent bank­ing cri­sis, has been able to slash in­ter­est rates. It seems what’s good for the goose in a cri­sis isn’t good for the gan­der.

Un­fair though it may seem, there’s one ex­pla­na­tion why the US dol­lar has strength­ened, drag­ging emerg­ing mar­ket cur­ren­cies weaker in its wake: be­cause the US gov­ern­ment is still seen as the safest place to park money. No mat­ter that an ex­tra $700bn had to be bor­rowed, Un­cle Sam is still “the man” dur­ing times of cri­sis.

One dif­fer­ence be­tween the cur­rent cri­sis and pre­vi­ous ones for emerg­ing mar­kets is that this time many are sit­ting on moun­tains of for­eign ex­change re­serves. Those re­serves are mostly the re­sult of ex­port earn­ings, which is es­pe­cially the case for oil ex­porters, such as Rus­sia, but also for oth­ers, such as South Korea. The re­serve-rich emerg­ing mar­kets have been us­ing their re­serves to stem the down­ward slide in their cur­ren­cies.

In Rus­sia’s case, a mas­sive amount of re­serves couldn’t stop a 1% de­val­u­a­tion of the rou­ble against a bas­ket of cur­ren­cies. Ac­cord­ing to Rand Mer­chant Bank cur­rency strate­gist John Cairns, Rus­sia lost about $50bn in re­serves in Oc­to­ber and $9bn over the week to 14 Novem­ber in de­fend­ing its cur­rency peg. Cairns warns the Rus­sians may have to make an­other, larger, de­val­u­a­tion in fu­ture. Neg­a­tive sen­ti­ment from such a move could spill over to the rand, which could move by as much as 50c against the US dol­lar.

It seems the mas­sive Rus­sian forex re­serves – put at $560bn by The Econ­o­mist mag­a­zine – only just cov­ered the ex­ter­nal debt of the coun­try’s banks and com­pa­nies. South Korea is in a sim­i­lar sit­u­a­tion, with its gov­ern­ment sit­ting on a moun­tain of re­serves but pri­vate com­pa­nies sit­ting on a moun­tain of for­eign debt.

There­fore, in some cases the high amounts of re­serves ac­cu­mu­lated cre­ated the il­lu­sion of safety against an at­tack on their cur­ren­cies. Cairns says Brazil has over the past six weeks sold as much as $46bn of its $200bn re­serves war chest. “The risk, as from Rus­sia, is that cur­rency weak­ness spills over into the rand at some time in the fu­ture,” Cairns says.

So far, SA has avoided us­ing its re­serves to try to shore up the rand. One rea­son is that SA isn’t sit­ting on the moun­tains of re­serves other emerg­ing mar­kets have amassed. It’s true SA’s forex re­serves sit­u­a­tion is a far cry from the dire straits that pre­vailed at the time of the 2001 cur­rency cri­sis, when SA had no net re­serves. SA’s in­ter­na­tional liq­uid­ity po­si­tion is now around $32bn.

Cairns says SA could use its forex re­serves to fight against rand de­pre­ci­a­tion. He says part of SA’s re­luc­tance to sell re­serves pre­sum­ably is be­cause its au­thor­i­ties worry that would send a sig­nal to the mar­ket that prob­lems ex­ist and so en­cour­age fur­ther spec­u­la­tion against the lo­cal unit. Says Cairns: “That could be re­solved by spec­i­fy­ing the re­serves sales in ad­vance. For ex­am­ple, stat­ing the SA Re­serve Bank would sell $500m of re­serves each month for the next year. While that would al­lay fears of re­serve de­ple­tion, there’s no in­di­ca­tion the Bank is think­ing along th­ese lines. The Bank’s un­will­ing­ness to use re­serves, con­trasts with the po­si­tion of most other coun­tries. In fact, most emerg­ing mar­kets (and even some de­vel­oped coun­tries, such as Aus­tralia) have sold dol­lars ag­gres­sively,” Cairns says.

It’s un­likely the Bank will take Cairns’s ad­vice, as an­nounc­ing a pre­pared­ness to sell dol­lars might be seen as a con­cern the rand is too weak. That may be­come a self-ful­fill­ing prophecy once cur­rency spec­u­la­tors smell blood.

One thing also seems clear: de­spite mas­sive forex re­serves, some emerg­ing mar­kets are bat­tling to stem the cur­rency tide. Much as those coun­tries and SA dis­like cur­rency volatil­ity, it ap­pears we’re go­ing to have to live with it.

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