Tapering tricky for emerging markets

THE recent meeting at Jackson Hole in the US of central bankers and finance ministers has raised the temperature around monetary policy.

This is especially so for emerging markets, with Finance Minister Pravin Gordhan flagging the need for coordinated action to subdue volatile currency markets.

During the Jackson Hole meeting, the rand touched R10.50/$, the weakest level since early 2009 when it was recovering in the wake of the global financial crisis and hit R11.85/$ when Lehman’s failed.

The 2008 crisis is where the foundation of the recent volatility was laid. It may not be over. And emerging markets are in it together, with the Indian rupee, Indonesian rupiah, Brazilian real and Turkish lira all struggling.

Since 2008, major central banks embarked on an unprecedented monetary experiment. Interest rates were first lowered to virtually zero by the US Fed and the Bank of England, the Swiss National Bank and the European Central Bank. The Bank of Japan had implemented a zero interest-rate policy 12 years earlier.

When the interest-rate ammunition was spent, they embarked on a money-printing spree called quantitative easing (QE). Labelled QE-1, followed by QE-2 and now QE-3, trillions of dollars were created and thrust into the global financial system. This flood of liquidity in a zero interest-rate environment was looking for yield, and found it in emerging-markets.

The dominance of the developed world’s monetary policies quickly fed back into emerging markets, which had to respond by cutting their interest rates to deflect some of the hot-money capital flooding into the global financial system.

Emerging market currencies strengthened and the rand recovered all the way to below the R7/$ level. The SA Reserve Bank cut the repo rate to 5%, taking the prime rate down to the lowest level since the early 1970s. This helped the post-2008 global crisis recovery but it is becoming apparent that there was a degree of illusion in that recovery.

Commodity prices recovered on Chinese demand, which had been driven in part by its own massive monetary stimulus. The consequence of the massive monetary experiment has been an explosion of debt-funded consumption that now threatens the global recovery.

Now the central bankers want to slow down their monetary policy, which will be achieved by first “tapering” the QE programmes.

So far, market reaction has not been encouraging. In the wake of the June US Fed meeting on interest rates, markets took a three-day plunge, forcing Fed officials to spend the next several weeks doing damage control. Stock markets managed to regain their footing, but not bond markets, with yields remaining high.

This month is when the great “taper” is expected to start, but it may be put off until December if data and market conditions are not supportive.

In anticipation of the tapering, emerging-market currencies that enjoyed strength in the buildup of QE are experiencing weakness. Hence Gordhan’s call for measures to control and temper the effects on emerging markets of the withdrawal of the developed world’s monetary experiment.

His call is justified given the culpability of the developed world in disrupting the rest of the world’s financial markets. This is an ongoing saga.

If only it were that easy. The innocent emerging markets are actually not that innocent. Over this period there has been a degree of macro deterioration. A little bit of populism in the budget has seen the government’s deficit remain stubbornly high and the debt:GDP ratio has risen from below 20% to over 40%. The current account deficit has ballooned as well, saddling SA with a dubious twin deficit problem.

Hart is chief strategist at Investment Solutions