As Warren Buffett says, “You never know who’s swimming naked until the tide goes out.” For the emerging economies, the financial tide is being pulled by the strong dollar, driven by the perilous blend of a loose US fiscal approach and tightening monetary policy. This is familiar. So who is swimming naked? Argentina, still recovering from the 12 years of the Kirchners’ leftwing populism, is today’s leading example. That, too, is familiar. Is Argentina unique? Alas, possibly not.
The central bank in Buenos Aires has blown $5bn of foreign exchange reserves in a week and enacted three shock rate rises in an attempt to halt the slide in the value of the peso. Yet the decision to raise its official rate from 27.5 per cent to the unsustainable level of 40 per cent is more likely to exacerbate panic in the market than calm it.
Argentina’s crisis need not spell disaster for other markets. When Argentina abandoned its currency peg and defaulted on its debts at the turn of the millennium, other emerging market currencies were relatively unscathed. Yet this time, Argentina’s woes are not isolated. Not only is there a global cause, in the stronger dollar and rising US interest rates. But there is also fairly widespread weakness.
Turkey is one obvious example. The country has a large structural current account deficit and rising inflation. As with Argentina, investors are concerned about the degree of independence of the central bank, although in Buenos Aires it is more a question of mixed messages than wrong messages. In Ankara, however, the increasingly autocratic and erratic President Recep Tayyip Erdogan has been barking orders directly at the central bank.
The Washington-based Institute for International Finance argues that, in addition to Argentina and Turkey, Ukraine, China (somewhat surprisingly) and South Africa are relatively vulnerable to a sharp shift in risk appetite. Yet the IIF is also relatively optimistic about Russia the Czech Republic, Colombia, Brazil and the Philippines.
The vulnerability of individual countries always varies. But most emerging economies appear to be in much better shape than in the run-up to previous crises: most now have floating exchange rates, for example, relatively low inflation, relatively extended maturities on debt and substantial foreign currency reserves. Yet history shows that the scale of the shocks to the global environment often matters even more to emerging countries. The rise in oil prices is one such shift. A full-blown trade war between the US and China is also not out of the question.
Until recently, investors had been reasonably relaxed. The prospect of war on the Korean peninsula, and with Russia in the Middle East had receded. Moreover, the level of dollar interest rates remains ultra-low by historical standards. Since few expect a big surge in inflation, the Federal Reserve is not expected to raise rates to anywhere near their historic peaks.
Nevertheless, further disruption is quite likely, even without big new shocks. The dollar could strengthen further, for example. The economies that are best prepared to weather the coming storms will be those with the right fundamentals, including strong fiscal positions and manageable debts.
Argentina, ironically, had been addressing longstanding imbalances in a way that would normally reassure the markets. Sadly, the government left too much to the central bank. The government needs urgently to get a grip on both inflation and fiscal imbalances. Rate rises and central bank intervention will fail to do the job. Much the same applies to many other places. It is simply not a good idea to swim naked.