I have an up-ed in today’s edition of UK’s City AM on the risk of major monetary policy mistakes – a repeat of the 1997 Asian crisis – in Emerging Markets in response to the recent currency sell-off across the EM universe.
THE EMERGING market sell-off has prompted central bankers to act. Yesterday, South Africa’s central bank raised its benchmark interest rate by 0.5 per cent to 5.5 per cent, citing the depreciation of the rand and an increased risk to the country’s inflation outlook. The Reserve Bank of India has also increased its benchmark rate by 0.25 per cent to 8 per cent. Most unprecedented of all, however, was the Turkish central bank’s decision late on Tuesday to hike its key policy rate from 4.5 per cent to 10 per cent in response to the recent sharp sell-off in the Turkish lira.
Turkey’s decision, in particular, left the impression of monetary planners acting in sheer desperation. Its central bank – like some of its emerging market counterparts – looks to have forgotten that its currency (at least officially) is free floating. Its aggressive tightening of monetary conditions bears all the hallmarks of a misguided attempt to quasi-fix its exchange rate – with dangerous potential implications…
…the interest rate hike this week suggests that Turkey now fails to realise quite how high the cost of a pegged exchange rate regime can be. The central bank’s attempt to prop up the lira by aggressively tightening monetary conditions is effectively an attempt to quasi-fix the exchange rate – and we will likely see the same kind of negative growth effects as if there had been an actual pegged exchange rate regime. Obviously, Turkey has not returned to a pure pegged exchange rate. But trying to curb the sell-off in the lira in this stop-go fashion is likely to have a similarly damaging effect on growth. Ultimately, if the Turkish central bank continues to seek to prop up its currency, the end result will be serious financial distress as well.
I certainly hope that Turkey’s desperate monetary tightening was a one-off. I equally hope that emerging market central bankers more generally realise that the best way to avoid a repeat of the 1997 Asian crisis is to allow exchange rates be determined by the markets. Otherwise, ill-informed central planners risk turning emerging market volatility into something much more worrying.
It has been a busy week for me. Here is a bit of comments and notes from Danske Bank’s EM team:
Storm turns into hurricane – EM sell-off escalates
Argentina – easing currency controls
Emergency monetary meeting in Turkey
Weak rouble – nothing new
Mapping the EM sell-off
South Africa – SARB delivers 50bp rate hike in order to tame inflation
Helping the lira, killing the economy?
…and from my blog: