Tariffs and interest rates: Emerging markets perfect storm
September was dominated by two big economic stories. The twin topics were the emerging markets’ currency rout and trade.
While Donald Trump set the cat among the pigeons with his tough talk on trade (particularly with regard to China), emerging market currencies seem to have entered a never ending tailspin.
It all started in early August, when the US President doubled down on Turkey, announcing sanctions on two cabinet members and doubled tariffs on steel and aluminum to 50 percent and 20 percent respectively.
The lira went into freefall at some stage, losing 45 percent against the dollar. We now stand at 42 percent but the downward trajectory continues. The Turkish situation was not helped by President Recep Tayyip Erdogan’s efforts to curb the independence of the central bank and his unwillingness to engage with the IMF or raise interest rates.
While rates are up 700 basis points since the start of the year, that may not be enough given that year on year inflation for August is running at almost 18 percent — way above the country’s 5 percent target. Rising gas and electricity prices are particularly problematic as Turkey imports most of its energy needs. The banks are suffering too, as many of them have borrowed in euros. This caused a ripple effect on the euro in early August, because Spain’s BBVA, France’s BNP Paribas and Italy’s UniCredit have a big exposure on Turkey.
The Turkish lira crisis spread like a wildfire to other emerging markets — especially to those with big current account deficits
The Turkish lira crisis spread like a wildfire to other emerging markets — especially to those with big current account deficits. The Indonesian rupiah was badly impacted as were the South African rand and the Russian rouble. (Russia’s biggest problem are the sanctions, which are biting and have taken their toll on the economy.)
The Argentinean Peso was hit by what can only be described as a tsunami. When the crisis broke its central bank immediately hiked rates by 500 basis points to 45 percent.
Markets were unimpressed by the world’s highest interest rates at the time. The peso continued to slide and inflation to rise. When President Mauricio Macri announced last week that he wanted to bring forward the disbursement of a $50 billion IMF loan, all hell broke loose. The currency has so far lost half of its value against the dollar this year. Not even the drastic increase of interest rates to 60 percent could stem its slide.
Inflation is rampant and Macri will have to take tough fiscal measures further undermining the middle class. To make matters worse, the $50 billion from the IMF will not go far, as Argentina faces debt repayments worth $24.5 billion next year.
Argentina’s situation is worse than Turkey’s as most of its debt is owed by the government whereas Turkey’s banks and corporations shoulder the lion’s share of foreign currency exposure. Turkey is also a neighbor to the EU and plays a vital role in containing the refugee crisis, which may give it some leeway.
The crisis originated in Turkey from a very specific set of circumstances. While the most affected countries all have current account deficits, they each have their individual set of problems. However, an emerging market’s narrative is forming irrespective of those circumstances.
The fundamental issue of the emerging markets rout goes well beyond that narrative though. The US Federal reserve has been raising interest rates and is set on a course of further gradual rate hikes this year and into next. The Fed has to do so because the US economy’s growth rates are high and further fueled by President Trump’s tax cuts.
This gives the investor the choice of an increasing yield in a low-risk environment. US rate hikes deprive emerging market currencies of the oxygen they so badly need, which is why even drastic rate hikes seem not to have done the trick in Argentina and may not do so in Turkey either. (Turkey is again in a different situation, because the euro, which is an important reference currency for the Lira, has not yet hiked rates and will not do so until at least the middle of next year.)
Trade also plays a role: China’s August purchasing managers index (PMI) — an important benchmark for economic growth —was at 50.6, at a 14 month low.
India’s PMI, at 51.7, fared only slightly better. India’s slowing growth is due to lower domestic demand, which can in turn be attributed to a falling currency.
China’s PMI has a direct correlation to the country’s outlook on trade, which has become lot less rosy since Donald Trump announced further tariffs on Chinese goods.
- Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources