John Whitefoot: The long-expected hit to the emerging markets is finally upon us. The fact that the emerging markets are taking a beating isn’t a total surprise; on the other hand, everyone running for the exits is.
But as physics proves, for every action there’s an equal and opposite reaction—nothing can escape physics; not even Wall Street or the emerging markets.
First, income-starved investors poured money into the emerging markets to take advantage of higher interest rates. Then, after the Federal Reserve said it would begin tapering its bond purchasing program, the money began to pour out of the emerging markets in earnest.
In a nearsighted effort to combat the slide in emerging markets’ currencies, central banks have been raising their interest rates. The Turkish central bank has taken drastic measures to entice investors to return—on January 29 the Turkish government lifted its overnight lending rate from 7.75% to an eye-watering 12% and its overnight borrowing rate from 3.5% to eight percent. The South African central bank raised its interest rate for the first time in almost six years. And the Russian ruble could be next.
This suggests that the underlying danger in the emerging markets isn’t their currencies per se, but the way the central banks are reacting to the slouching currencies. Instead of lowering rates to boost their economies, the central banks have been raising interest rates to prop up currencies.
This could be especially dangerous when you consider that emerging markets make up half of the world’s gross domestic product (GDP). If emerging markets try to follow the U.S. and raise interest rates, it could cripple their own economies (companies would face higher costs, for one). Rising interest rates wouldn’t have the same dramatic effect on the U.S., because the economy is so huge and consumer spending fuels the majority of growth in America.
The fact of the matter is that the economies of many emerging markets are performing better than some of the developed economies and are better-positioned going forward. On top of that, falling currencies would actually be a boon for exports.