Emerging Market Volatility Paints a Murky Picture for 2014

The year has got off to a shaky start for several of the world’s emerging market (EM) economies. Turkey, India and South Africa all raised interest rates last week to counter their weakening currencies.

With monetary policy tightening in the US and China, policymakers in the EMs are attempting to mitigate the effects. The US Federal Reserve’s monetary stimulus is a key reason why the EMs have seen a steady flow of cash over recent years.

As Nouriel Roubini, chairman of Roubini Global Economics and professor of economics at the Stern School of Business observed, the economies of India, Indonesia, Brazil, Turkey and South Africa are now regarded as particularly vulnerable. Dubbed the ‘Fragile Five’ because each suffers from a combination of twin fiscal and current account deficits, falling growth, rampant inflation and political uncertainty, three of them were lauded only a few years ago as the fast-growing so-called ‘BRICS’ (Brazil, Russia, India, China and South Africa).

“Pressure has now returned to haunt the key EM currencies whose central banks have so far raised the cost of borrowing, but pressure valves are also now being tested elsewhere,” Andrew Wilkinson, chief market analyst at Interactive Brokers, told

A day after
criticising the lack of global economic policy coordination
, Reserve Bank of India (RBI) governor Raghuram Rajan, spoke out again about the US Fed’s decision to reduce its bond purchases by US$10bn to US$65bn. “I have been saying that the US should worry about the effects of its policies on the rest of the world,” he said.

Turkey in particular is struggling mightily, noted Kathryn Langridge, manager of the Jupiter Global Emerging Markets Fund. “With an external deficit approaching 7% of gross domestic product (GDP), Turkey is highly vulnerable to a reversal of short-term capital flows,” she explained in a market commentary.

“It has been forced to spend dwindling reserves on supporting its currency, which has experienced significant depreciation since political tensions resurfaced in December.”

Other fiat currencies, such as the South African rand (ZAR), the Brazilian real (BRL), the Russian rouble (RUB) and the Indonesian rupiah (IDR) are also waning.

Langridge noted that the unexpected decline of China’s manufacturing sector purchasing manager’s index (PMI) has exacerbated fears of a slowdown at a time when money market rates have jumped. She believes the spike in costs can be attributed to seasonal factors associated with the Chinese New Year, as well as a crude attempt by the authorities to bring credit under control, at the expense of some economic growth.

However, even though a bailout has prevented the imminent default of a trust loan product in China, “there are persistent and valid concerns about financial companies’ management of credit risks in the shadow banking system… even though this is representative of China’s broad economic rebalancing through more efficient capital allocation and pricing,” Langridge wrote.

Though Langridge sees clear evidence of serial economic mismanagement in a number of emerging economies such as Argentina, she pointed out that others are addressing the structural problems that have hindered economic growth potential. “Mexico, under the now established administration of Enrique Pena Nieto, has embarked on an ambitious programme of financial, energy and tax reform within the framework of a balanced budget and low debt levels,” she wrote.

Langridge added that monetary tightening in the US and China is an indication that the overall global economy is strengthening, which she believes will ultimately result in recovery in the emerging markets. For now though, emerging markets’ struggles are likely to reinforce investors’ preference for developed markets.


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