Reserves no guarantee
Some emerging markets fight a losing battle
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.