Emerging nations act to curb dollar impact

Nowhere is the weaker dollar hurting more than in emerging markets.

The US currency has fallen by as much as 40 per cent since March against some emerging market currencies – such as the Brazilian real and the South African rand – which is making life extremely painful for some of their exporters.

The pain has reached the point where a number of developing countries have started to take measures to restrain the rise of their currencies. These include direct intervention in the foreign exchange markets as well as capital controls.

Brazil was the first country to take action to curb the rise of its currency. It introduced capital controls last month with a 2 per cent tax on foreign portfolio investments.

It followed this up this week with warnings that it could introduce further controls when Guido Mantega, the finance minister, said that foreign exchange markets had given the real an “exaggerated” valuation.

Russia, another of the Brics (Brazil, Russia, India and China), highlighted its concerns yesterday, selling $700m to ease the pressure on the rouble, which has jumped to its strongest level against the dollar since December.

Taiwan also took action this week by banning foreign funds from investing in time deposits, or bank and savings accounts. This was designed to stop speculators from driving the Taiwanese dollar higher.

Central bankers in South Africa, Thailand and Chile have all raised their heads above the parapet, too, to warn about their rapidly appreciating currencies.

Analysts say that the moves by Brazil, Taiwan and others represent a new awareness of the dangers of bubbles in asset prices, ranging from equity to property markets, building up in their economies.

All have been beneficiaries of a global carry trade, in which investors sell lower-yielding assets, such as the dollar, in their search for higher yields elsewhere.

That search for yield has helped drive one of the most spectacular rallies ever seen in emerging market equities while forcing down the spreads on EM bonds. Stocks have risen more than 100 per cent since March, according to FTSE All World indices, while the spread of EM sovereign bonds over US Treasuries has more than halved to 300 basis points. Flows into emerging market equity funds have jumped to $65bn in the past eight months, say EPFR Global, the data provider.

Nigel Rendell, senior emerging market strategist at RBC Capital Markets, says: “We have seen a spectacular rally – but the danger is: Has it gone too far?

“A lot of policy-makers clearly think it has, and it is time to take action or face the threat of exports suffering and asset-price bubbles developing.”

Emerging market policy-makers are well aware that their exports will prove critical in maintaining economic growth next year and beyond. Shahin Vallee, emerging market strategist at BNP Paribas, says: “The concerns of emerging market policy-makers centre on two things. The disruption that higher exchange rates can have on their monetary policies and the damage appreciation can have on their exports.

“It is a good thing that these countries are already thinking about this and not just congratulating themselves on the big rally and demand for their assets.

“Even the International Monetary Fund, which has always been sceptical when it comes to capital controls, has been very quiet on this issue. There has been no criticism of Brazil.”

Stephen King, chief economist at HSBC, adds: “The emerging market economies are, in essence, expressing their concerns over speculators, simply investing money in their markets to take advantage of higher yields and expectations that their currencies will strengthen.”

“There is a very good chance of bubbles developing and exports being hit if speculation is not curbed.”

However, time should prove to be the best antidote.

Many analysts say that there will be a pause in the emerging market rally in the coming weeks as many investors close their books until year-end and wait for clearer signs over the strength of the global recovery in 2010. Investors are also being more cautious as valuations rise. This could boost the dollar and put a check on emerging market currency appreciation.

China will inevitably play a pivotal role. Significantly, China hinted for the first time for more than a year yesterday that it might allow the renminbi to appreciate against the dollar. This would help the smaller Asian economies, which sell a large chunk of their exports to Beijing.

The IMF said at the weekend that the renminbi, which has, in effect, been pegged to the dollar since the middle of last year, was “significantly undervalued”. The US, the European Union and Japan have all stepped up pressure on China to allow its exchange rate to strengthen.

Mr Vallee says: “The Chinese may allow their currency to appreciate soon. That will be a big help to the rest of the emerging market world from Brazil to Asia as China is such a big market. If other emerging market exports become more competitive in relation to China, that will help them considerably.”

Mr Rendell adds: “If the emerging market rally shows signs of running out of steam and there is any worry over the outlook for the world economy, then the dollar will strengthen. If the Chinese revalue their currency, that will also boost other emerging markets.

“The emerging markets can definitely overcome the problems of the strength of their currencies, which in many respects reflect the success of their economies, and the way their policy-makers have navigated the financial crisis.