The emerging-market currency scare continues, but the good news is that the damage to date has been remarkably contained. Turkey’s central bank on Thursday became the latest to raise interest rates to stabilize the lira. But the bigger story is that markets are culling the herd to attack the weakest instead of spreading currency contagion.
This isn’t an act of charity but seems to be a rational attempt to sort bad from good economic management and political credibility. The global economy is growing, especially the U.S. as capital flows to America after tax reform and the Federal Reserve raises interest rates. This sorting seems to be insulating the likes of Malaysia, Mexico and Thailand, which have all suffered from previous currency routs.
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But it also paints a bull’s-eye on the weakest countries, such as Turkey. Before Thursday’s rate increase the lira was down some 40% versus the dollar this year. That compares to an 8% decline in a basket of currencies of smaller U.S. trading partners measured by the Fed.
Turkey has a heavy burden of dollar- and euro-denominated debts, especially in construction and real-estate industries. President Recep Tayyip Erdogan weighs on the economy with fulminations against central-bank independence and the evil influence of the U.S. dollar. President Trump has piled on with sanctions to get the return of an American pastor held in Turkey on phony charges.
The Argentine peso is another soft currency target, depreciating 50% or so this year. The country still hasn’t repaired the economic damage inflicted by President Cristina Kirchner, including large government debt to fund public works and patronage.
South Africa’s rand has fallen about 15% against the dollar this year, as investors rebel against a government plan to expropriate farmland. India is also on investor probation, with the rupee down some 13% this year amid worry about a trade deficit and the fate of President Narendra Modi’s inconsistent reform. The Brazilian real is down 20% as a leftward lurch looks possible in October’s presidential election.
All of which should be a warning for countries to use this moment to shape up. Investors are looking past short-term moves like interest-rate hikes for signs that governments are serious about economic reforms such as spending restraint, debt reduction, tax reform and trade liberalization. Countries that have lost monetary credibility due to political interference—Turkey—should turn to currency boards or dollarization.
Market pressure will grow as developed-economy central banks continue to raise interest rates and unwind their post-crisis asset purchases. Investors will have more U.S. and European bonds to buy as the Fed and European Central Bank reduce their portfolios. The price of money is rising, leaving governments with less room for policy error.
This year’s selective emerging-market panics are a sign that as liquidity becomes scarcer, developing countries will have to work harder to attract capital. Better to move on reform now while the global economy is growing rather than wait until your country is a target.
Appeared in the September 14, 2018, print edition.