The sharply rising risk of Emerging Market policy blunders

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.

 Quoting myself:

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?

EM turmoil: It ain’t over till the Chinese lady sings

…and from my blog:

Argentina’s peso plunges

Please don’t fight it – the risk of EM policy mistakes

The EM sell-off and China as a global monetary superpower

Leave a comment


  1. Silvano

     /  January 30, 2014

    The majority of debt held by rated turkisch corporates is denominated in foreign currency, mostly USD and EUR. The same holds true for MFIs. Government just issued fx denominated bonds and thrown them in market trying to stop depreciation. Strongly negative CA, short term debts, inconsistent time and currency mismatch in banking sector. Likely, they’re gone. Even if you let turkish lira floating, they’re gone. Just call IMF or beg Uncle Sam.

  2. Hi Lars, Turkey might not be overdoing it. the policy rate of 10% is what taylor rule would suggest to hit a 5% inflation target — assuming equilibrium real rate of 2.5%, output gap of 0 and inflation gap of 2.5%. I think Bacsi is exercising his independence while the attention is fixated on the PM’s scandal.

  3. John Becker

     /  February 5, 2014

    Turkey has high inflation, or as the market monetarists like to put it, excessive NGDP growth. Maybe they are trying to bring NGDP growth down to a more normal rate after 10 years of inflation around 10%. Their output gap is relatively small by historical standards since they usually have unemployment around 9%. This could end up putting their economy on sounder footing much like Paul Volcker did for the United States in the 1980s. Their rate cut actually makes me more optimistic about emerging markets since high and unstable NGDP growth like they have is generally bad for economic calculation.


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