Currency Wars Lose to Inflation, Emerging Markets to Win
As recently as last month, governments of emerging economies from South Africa to Brazil warned that competitive devaluations might be needed to keep their strengthening currencies from stifling economic growth.
Now, talk of currency controls is being abandoned and interest rates are rising as record food prices and oil at $100 a barrel make inflation the bigger threat. That means developing nations will keep outperforming in the foreign-exchange market, according to Morgan Stanley.
South Africa’s finance minister and Indonesia’s deputy central bank governor said last week that stronger currencies may quell rising prices. Russia’s finance minister said Feb. 21 the central bank will favor a “very flexible” exchange rate. Brazil Finance Minister Guido Mantega, who spoke of a “currency war” in September when he pledged to buy dollars to curb the real, declared a “truce” two months later. Peru, China, Colombia, Indonesia and Russia raised interest rates this month.
“If your main macroeconomic problem shifts from one of too weak growth to one of too high inflation, then that is going to lead you to look at tightening monetary policy,” said Jens Nordvig, a managing director of currency research at Nomura Holdings Inc. in New York. “The quickest way to put a cap on inflation is to look at ways that would strengthen your currency.”
Protests in Egypt, Bahrain, Libya and Tunisia drove oil above $100 a barrel in New York for the first time since October 2008, raising concern that energy prices will spark inflation. An index of 55 food commodities climbed 3.5 percent in January from a month earlier to a record 231 points, the United Nations’ Food and Agriculture Organization said Feb. 3.
Economists at Barclays Capital estimated in a report dated Feb. 25 that inflation is accelerating at a 6 percent rate in emerging economies, compared with less than 2 percent in developed nations.
After noting in October the rand was “overvalued,” South Africa’s Finance Minister Pravin Gordhan said Feb. 23 that a “rapid” weakening may fuel inflation. His comments were echoed a day later by the Indonesian central bank’s Deputy Governor Hartadi Sarwono, who said policy makers will let the rupiah strengthen to help keep prices in check.
Brazil raised its main interest rate on Jan. 19 for the first time since July, just two months after Mantega said the real had reached a “reasonable” level. Bank of Thailand Governor Prasarn Trairatvorakul said Jan. 26 that rates will need to rise to damp inflation even after policy makers boosted them for a fourth time in seven months on Jan. 12.
“Emerging economies, especially in Asia, are facing significant domestic inflationary pressures, which you see in wages and prices,” said Gabriel de Kock, head of foreign- exchange strategy at Morgan Stanley in New York. Food and energy costs are also experiencing “significant upward shocks” as international commodity prices surge, he said.
Morgan Stanley favors the ruble, Mexican peso and the ringgit as investors speculate that central banks in commodity- producing countries such as Russia, Mexico and Malaysia will boost rates, according to a Feb. 4 report from a team of strategists led by Rashique Rahman in London.
The ringgit will appreciate 9 percent this year to 2.8 per dollar, while the Colombian peso will gain about 11 percent, the New York bank forecasts. The Malaysian currency will end the year at 2.97 per dollar, from 3.0510 today, according to the median estimate of 18 analysts surveyed by Bloomberg. Colombia’s peso will be at 1,850 by the fourth quarter, from 1,907.15 last week, a separate survey showed.
Demand for Safety
Most emerging-market currencies fell last week as turmoil in Africa and the Middle East led investors to seek safer assets. The ringgit lost 0.6 percent, with the peso weakening 1.2 percent to 1,898.75. South Korea’s won depreciated 1.3 percent to 1,126.45 and the real declined 0.4 percent to 1.6684.
Developing-nation currencies rallied in the past two years as interest rates at about zero in the U.S. and Japan encouraged investors to seek higher-yielding alternatives. The gains were led by the rand’s 44 percent surge versus the dollar.
Pacific Investment Management Co. prefers the currencies of emerging economies and commodity exporters over the dollar and the euro, according to Andrew Balls, a London-based managing director at firm.
‘Expression’ of Growth
“Our investment view is one of wanting to be underweight both the euro and the dollar and to be overweight sources of what we would see as an expression of stronger growth,” Balls told reporters at a media briefing in London today.
Emerging nations may still balk at abandoning capital controls, even as they boost rates to combat inflation, said Jan Loeys, chief market strategist at JPMorgan Chase & Co. in New York. Colombia’s Banco de la Republica said Feb. 25 it will extend daily dollar purchases in the local market for at least three more months to limit the peso’s gains after it unexpectedly raised interest rates for the first time in 10 meetings.
“Countries are worried that if they let their currencies appreciate, that would just be like waving a red flag in front of the bull, which is the global capital investor,” he said. “They are trying to tighten domestically while trying to avoid that they have massive capital inflows.”
Outlook for Sweden
Sweden shows that growing economies can withstand stronger currencies if their exports are competitive. The economy may expand 4.05 percent this year, according to the median estimate of 10 economists surveyed by Bloomberg, even after the krona appreciated 7.5 percent in the past six months, the most in a basket of 10 developed-nation currencies as measured by Bloomberg Correlation-Weighted Currency Indexes.
Soaring energy prices threaten to slow the global recovery and stoke inflation. In the U.S., an extended $10 increase in oil cuts 0.5 percentage point off growth over two years, according to Deutsche Bank AG. Crude soared to $112.14 a barrel in London last week, the highest close since August 2008.
“When you have the potential for a big supply-side shock, which has the potential to compromise economic growth, then allowing your currency to appreciate isn’t necessarily a good thing,” said Alan Ruskin, global head of Group-of-10 foreign- exchange strategy at Deutsche Bank in New York.
Investors pulled $1.9 billion from developing-nation stock mutual funds in the week to Feb. 23, the fifth week of outflows, according to EPFR Global data cited by Citigroup Inc. on Feb. 25.
Goldman Sachs View
“You don’t need to worry about stopping inflows when they’re not there anymore,” said Fiona Lake, an economist at Goldman Sachs Group Inc. in Hong Kong.
While emerging-market leaders blame foreign-exchange appreciation on the Federal Reserve’s policy of printing money to buy bonds and keeping rates at almost zero, Treasury Secretary Timothy F. Geithner said at the Group of 20 meeting this month in Paris that trade imbalances have kept currencies of nations such as China “substantially undervalued.”
China’s yuan has strengthened 4.3 percent since mid-2008 to 6.5719 per dollar even as gross domestic product expanded 10.3 percent last year, 9.2 percent in 2009 and 9.6 percent a year earlier and has now surpassed the economy of Japan to become the world’s second-largest.
Developing countries most reliant on imported oil will be among the first to increase rates, said Luis Costa, an emerging- markets strategist in London at Citigroup. These nations are susceptible to sudden commodity price jumps, with fuel and mining products accounting for about 36 percent of South Korea’s imports, 25 percent in China, 27 percent for Turkey and 24 percent for Indonesia, the New York-based bank estimates.
“Countries like Turkey that are big importers of inflation can’t afford to keep pursuing loose monetary policy and exchange-rate depreciation,” Costa said. Turkey’s central bank left its main rate unchanged on Feb. 15 after two months of cuts to assess whether curbs on lending are reducing consumer demand.
Russia’s Bank Rossii won’t seek to stem ruble gains and will favor a “very flexible” exchange-rate policy to help contain inflation, Finance Minister Alexei Kudrin said Feb. 21. The Finance Ministry and the central bank may keep inflation from exceeding the government’s goal of 7 to 8 percent, he said.
“Emerging markets are scared of inflation, especially food and energy inflation, so there’s merit in allowing their currencies to appreciate,” said Werner Gey van Pittius, part of a team overseeing about $70 billion in assets at Investec Asset Management in London. “Your oil exporters will be fine, but those that are big energy importers need to worry.”
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