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Emerging-Market Rout Seen Enduring on Low Real Rates

A customer receives her change in Turkish lira after purchasing goods from a trader in the spice market in Istanbul. Central bank rate increases in Turkey, India and South Africa last week failed to contain January’s 3 percent selloff in emerging-market currencies. Photographer: Kerim Okten/Bloomberg
A customer receives her change in Turkish lira after purchasing goods from a trader in the spice market in Istanbul. Central bank rate increases in Turkey, India and South Africa last week failed to contain January’s 3 percent selloff in emerging-market currencies. Photographer: Kerim Okten/Bloomberg

Feb. 3 (Bloomberg) -- Inflation-adjusted interest rates are still too low in developing nations for Citigroup Inc. and Goldman Sachs Group Inc. to foresee an end to the worst emerging-market currency selloff in five years.

One-year borrowing costs in Turkey are 3.6 percent, less than half of the average in the three years before the 2008 global financial crisis, even after the central bank doubled its benchmark rate last week, according to data compiled by Bloomberg. The real yield for Mexico is almost zero, while South Africa’s is 1.3 percent, compared with an average of 2 percent over the past decade.

Central-bank rate increases in Turkey, India and South Africa last week failed to contain January’s 3 percent selloff in emerging-market currencies. Citigroup says yields aren’t high enough to attract the capital needed to finance current-account deficits in some of those nations. Competition for capital is intensifying with the Federal Reserve paring monetary stimulus, while the International Monetary Fund is calling for “urgent policy action.”

“When you have low real rates and try to finance your current-account deficits, it usually won’t work,” Dirk Willer, a Latin America strategist at Citigroup, the second-largest currency trader, said in a phone interview from New York on Jan. 31. “If the U.S. is repricing for higher rates, it’s very difficult for you to get away with lower rates. South Africa and Turkey are not safe yet.”

Global Exodus

Global funds pulled $6.3 billion from emerging-market stocks in the week through Jan. 29, the biggest outflow since August 2011, according to Barclays Plc., citing data from EPFR Global. More than $12 billion has fled the funds this year, already approaching 2013’s outflow of $15 billion.

One-year real yields in developing economies, based on the difference between interest-rate swaps and consumer-price inflation, are about 1 percent, according to Goldman Sachs. While rising, the rates are lower than the average of about 2 percent from 2004 to 2013, a model at the New York-based bank shows.

Turkey’s real yields may come under further pressure after a report showed today that the nation’s annual CPI accelerated to a faster-than-anticipated 7.48 percent in January, from 7.4 percent the previous month.

Raising Rates

Turkey’s central bank raised the benchmark one-week repurchase rate to 10 percent from 4.5 percent at an emergency meeting on Jan. 28, a day after the lira fell to a record 2.39 per dollar. The currency fell 1.3 percent to 2.2846 as of 3:45 p.m. New York time and it’s down 6 percent since Dec. 31, the worst start to a year since 2009.

South Africa’s rand weakened to a five-year low of 11.3909 per dollar on Jan. 30, even as the central bank unexpectedly raised interest rates by a half-percentage point to 5.5 percent. The currency declined 6.8 percent this year to 11.2616 per dollar. India’s rupee has fallen 1.2 percent as central bank Governor Raghuram Rajan surprised analysts by raising the repo rate to 8 percent.

Argentina’s government allowed the peso to devalue by 19 percent in January as private banks boosted deposit rates. In Hungary, the central bank bucked the trend, reducing the benchmark by 0.15 percentage point to a record 2.85 percent on Jan. 21. The forint tumbled last week to a two-year low of 314.23 per euro.

‘Sudden Stop’

“If policy makers don’t respond appropriately to signals from the market, and very few in EM have done so convincingly so far, then asset prices continue to pressure the economy directly,” Manoj Pradhan and Patryk Drozdzik, London-based economists at Morgan Stanley, said in a client report on Jan 27. “At extreme times, this results in a sudden stop” in capital flows, they wrote.

The interest-rate increases are a reversal of the trend over the past five years, when the Fed’s monetary stimulus boosted investment around the world and allowed central banks in developing countries to cut borrowing costs. Cheap money encouraged consumption, widening trade deficits and fueling inflation.

Turkey’s shortfall in the current account, the broadest measure of trade and services, amounts to more than 7 percent of its gross domestic product, making the nation more reliant on foreign capital. Brazil’s consumer prices stayed above the central bank’s target since August 2010, eroding the competitiveness of the economy.

Fed Stimulus

The real interest rate for Mexico is 0.04 percent, compared with an average 2.4 percent over the past decade, according to data compiled by Bloomberg. At 24 percent, Argentina’s deposit rates are 4 percentage points below the annual inflation that opposition lawmakers reported.

Now that the Fed is withdrawing the stimulus, the interest rates aren’t enough to compensate for the risk of putting money into emerging markets, according to Goldman Sachs. The U.S. central bank announced Jan. 29 plans to pare its bond purchases by another $10 billion to $65 billion.

“For many EMs, moving to a sustainable pace of growth and reducing external imbalances requires a combination of weaker currencies and higher rates,” Goldman Sachs strategists led by Kamakshya Trivedi wrote in a Jan. 30 report titled “It ain’t over ’til it’s over.” “In most places, real rates are only just normalizing from extremely low levels.”

Rout Spillover

The rand, lira and real will weaken further, while the selloff may spill over to currencies with “stronger fundamentals” including the Mexican peso, Hungarian forint and South Korean won, according to Trivedi.

A Bloomberg customized gauge tracking 20 emerging-market currencies has fallen 3.5 percent this year, making the worst start since 2009. The index has tumbled 9.4 percent over the past 12 months, bigger than any annual decline since it slid 15 percent in 2008.

The premium investors demand to hold emerging-market local-currency debt over five-year U.S. Treasuries increased to 5.76 basis points, the highest since June 2012.

“The market will have to start differentiating these countries which have already experienced a significant exchange-rate adjustment and those countries where the central banks would rather enjoy lower interest rates for longer,” Anders Faergemann, a senior portfolio manager at PineBridge Investments LLC in London, said in an Jan. 31 e-mail.

The IMF said Jan. 31 that some developing countries need to take action to “improve fundamentals.”

Chinese Demand

A decline in U.S. Treasury yields last month provided little relief for emerging market currencies as China’s $4.8 trillion of shadow banking debt raised concern about the growth outlook for a country that buys everything from Chile’s copper to Brazil’s iron ore. Exports from developing countries will grow 5.8 percent this year, compared with an average 7.3 percent over the decade through 2013, according to the IMF forecast.

The lack of export growth means raising interest rates to cut consumption and imports is the only way for countries such as Turkey and South Africa to reduce their trade deficits, according to David Lubin, the head of emerging-markets economics at Citigroup.

Higher interest rates, in turn, will erode corporate earnings and slow economic growth, dimming the allure of their currencies, said Lubin.

“Having ‘won’ tighter monetary policy from these countries, the market is now faced with a new problem,” Lubin wrote in a Jan. 30 client note. “How to price these countries’ currencies when their growth outlook has taken a turn for the worse? And so, it is difficult to call an end to currency adjustment in EM.”

To contact the reporters on this story: Ye Xie in New York at; Andrea Wong in New York at

To contact the editors responsible for this story: Dave Liedtka at; David Papadopoulos at

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