Emerging Markets
The worst sell off in emerging-market currencies in five years is beginning to reveal the extent of the fallout from the Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability (Bloomberg, 2014).
The Turkish lira plunged to a record and South Africa’s rand fell yesterday to a level weaker than 11 per dollar for the first time since 2008. Argentine policy makers devalued the peso by reducing support in the foreign-exchange market, allowing the currency to drop the most in 12 years to an unprecedented low.
Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus (Bloomberg, 2014).
Two very troubling things:
1. uncertainty about the Fed policy,
2. Combined with concerns about growth, particularly in China. It’s difficult to justify that it’s time to go out and buy emerging markets at the moment
Investors don’t invest in emerging markets like they do in developed markets. Capital rushes in when the economy is hot; when the economy cools, investors dump their local currency holdings (Forbes, 2014). That leaves piles of devalued local currency which the central bank is hard-pressed to prop up. (In developed markets like the U.S., United Kingdom, Japan, in contrast, investors are more willing to hold on to the currency.)
In the midst of the Great Depression, President Franklin D. Roosevelt said, “We have nothing to fear but fear itself.” Fear of weakening emerging market economies – and the panicked reactions that follow – is a bigger driver of currency depreciation than the weakness itself. It is irrational exuberance in reverse (Forbes, 2014).
We’ve been seeing that phenomenon play out on the main stage for the past couple of weeks. The Argentine peso plummeted 15 percent in a single day (January 23rd); the “contagion” quickly spread to other emerging markets, including most prominently Turkey, South Africa, and Russia. It was what Bloomberg has dubbed “the single biggest sell off in emerging market currencies since 2009.”
Argentina – In January, the Argentine peso fell 23percent. The most dramatic peso depreciation since the country’s 2002 financial crisis was triggered by the central bank’s decision to stop intervening in the markets to maintain the peso’s value – intervention that was increasingly costly, draining the country’s foreign currency reserves (Forbes, 2014).
Turkey – The Turkish lira fell 6 percent in January; at its low point, the lira was down 9 percent from January 1st. On January 28th, the Turkish central bank took action to brace the falling lira, raising its benchmark one-week lending rate for banks from 4.5 percent to 10 percent. The lira rallied, then gave up those gains, and then recovered slightly (Forbes, 2014).
South Africa – The South African rand fell 7.5 percent in January, its weakest level since 2008. The currency continued to fall even after the central bank raised its benchmark interest rate to 5.5 percent from 5.0 percent – the first rate increase in almost six years (Forbes, 2014).
Russia – In January, the Russian ruble fell 7 percent, hitting a five-year low. But unlike the central banks in Turkey and South Africa, which have raised interest rates in attempts to prop up their currencies, Russia’s central bank has maintained a hands-off approach (Forbes, 2014).
What is causing the panic?
A confluence of factors is causing the emerging market panic. The first is the pull-back of stimulus in the U.S. Since September 2012, the Federal Reserve has pumped massive amounts of liquidity ($85 billion at its highest) every month into the global market in what has come to be known as “quantitative easing.” In December 2013, outgoing Fed Chairman Ben Bernanke announced the beginning of tapering – a $10 billion reduction in monthly bond buying. On January 29th, the Fed announced that it would reduce its bond buying an additional $10 billion, to $65 billion a month.
Much of the capital that the Fed was infusing into the market through its bond buying flowed to emerging markets. With the Fed tapering off quantitative easing, that liquidity is drying up. In simple terms, no more easy money. And that means that growth in emerging markets will, in all likelihood, be both more expensive, and slower (Forbes, 2014).
Both the tapering of stimulus in the U.S. and weakening of emerging market economies lead to currency volatility (clearly), which leads to panic, which leads to more volatility.
Emerging markets don't have enough foreign-money debt this time around to make their falling currencies much of a concern. What is a concern is whether their central bankers realize this. They might overreact—they might already be—and raise rates to prop up their currencies, when they should be lowering them to prop up their economies.
Zambia
THE Kwacha recently hit a historical-low against the United States dollar for the first time after the 2008-09 global financial crisis, as the foreign exchange market continued to witness low greenback supply
Similarly, Standard Chartered Bank says increased demand for the dollar resulted in the weakening of the Kwacha“
There is a sizeable mismatch between demand streaming mainly from local corporates and real money market players as compared to the current level of supply for the dollar which is likely to see the currency remain under pressure for the time being,” the bank says in its daily brief (Daily Mail, 2014).
The annual rate of inflation, as measured by the all items Consumer Price Index (CPI) for January 2014 was recorded at 7.3 percent compared to the 7.1 percent recorded in December 2013. This means that on average, prices increased by 7.3 percent between January 2013 and January 2014 (CSO, 2014)
Export Market Shares, December and November 2013
The Southern African Development Community (SADC) was the largest market for Zambia’s total exports, accounting for 32.6 percent in December 2013. Within SADC, Congo DR was the dominant market with 47.3 percent. Other notable markets in SADC were Zimbabwe, South Africa, Namibia and Tanzania.
Asia regional grouping was the second largest market for Zambia’s total exports, accounting for 27.2 percent in December 2013. Within Asia, China was the dominant market with 80.3 percent. Other notable markets in Asia were United Arab Emirates, Japan, India and Singapore.
Import Market Shares
The major source of Zambia’s imports in December 2013 was South Africa, accounting for 38.1 percent. The major import products from South Africa were Machines, structures and parts of structures, of iron or steel, contributing 9.4 percent.
Conclusion
South Africa has experienced the effects of emerging market contagion like other emerging markets. South Africa is Zambia’s biggest source of Imports. Dollar flows between the two countries are highly correlated. The supply of Dollars has been low due to investors pulling their money out of emerging markets on speculation about US Fed QE. This will continue to have ripple effects on the economies of emerging markets and the periphery. Zambia does not exactly qualify as a leading emerging market but is in the emerging market periphery.
There is a fundamental level at which the Kwacha should be trading and Bank of Zambia has figure which it uses to calculate this. The problem is that the emerging market currency volatility has created a contagion which had affected the supply of Dollars across the emerging markets and the periphery. This has resulted in a shortage of supply of Dollars in Zambia causing the sharp depreciation we have witnessed.
Recommendation
The Bank of Zambia faces a dilemma.
They could raise rates and get a foreign credit boom, or cut rates and have a domestic credit boom. If the central bank keep, or raise, rates high where they "should" be, it will only attract more "hot money"—quick, speculative capital looking for the best return—from abroad. This will make exports even less competitive by pushing up their currencies more, and set off a lending boom that could reverse itself at the click of a mouse.
But it is a bit of a catch-22. If the central banks keep rates lower than they should be, it will make the economy less attractive to yield-hungry foreign investors. Less capital will flow in, and exports will not be as priced out by a too-high currency—but persistently too-low rates will risk inflation and a credit boom of their own making.
I suggest Bank of Zambia wait it out and if any action should be taken I suggest doing the opposite of logical thinking and actually drop rates to support the local economy. Inflation may be a problem but the robustness of Zambia’s economy to withstand emerging market periphery shocks will improve.
You can download this full academic article at the link below.
Download via academia.edu
References
Bloomberg. (2014, January 24). Contagion Spreads in Emerging Markets as Crises Grow. Retrieved February 20, 2014, from Bloomberg: http://www.bloomberg.com/news/2014-01-24/contagion-spreads-in-emerging-markets-as-crises-grow.html
CSO. (2014, January 31). Bulletin January. CSO Bulletin, pp. 2-19.
Daily Mail. (2014, February 17). Kwacha hits histotic low against US dollar. Retrieved February 20, 2014, from Daily Mail: http://daily-mail.co.zm/blog/2014/02/17/kwacha-hits-histotic-low-against-us-dollar/
Forbes. (2014, February 3). Why Panic-Prone Emerging Markets Are Breaking Down In 2014. Retrieved February 20, 2014, from Forbes : http://www.forbes.com/sites/steveschaefer/2014/02/03/why-panic-prone-emerging-markets-are-breaking-down-in-2014/
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