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  • Risky Business in Emerging Markets

    Emerging markets have been taking a beating in 2014. As money rushes out of these economies and currencies depreciate, central banks in Turkey, South Africa, and Brazil have been forced to intervene.

    Much of the diagnosis for emerging-market troubles has been focused on the U.S. Federal Reserve’s taper. The argument goes that as the Fed withdraws its monetary stimulus and bond yields rise, cash will flow out of emerging economies. But this isn’t the whole picture.

    The most dramatic declines in emerging-market currencies have occurred in January, a month in which the Turkish Central Bank doubled its short-term interest rate, and South Africa and Brazil followed suit. Yet, as the taper has continued, U.S. bond yields have actually fallen despite the emerging market sell-off. Since the Fed announced its taper on December 18, yields of 10-year and 30-year U.S. Treasury bonds have declined 9 percent and 8 percent, respectively.

    Why was there a dramatic sell-off in January, despite falling yields? The answer is political risk. Increased political risk in these economies has contributed just as much to emerging-market woes as the Federal Reserve has—if not more.

    In Turkey, uncertainty has increased since Prime Minister Recep Tayyip Erdogan’s crackdown on the police force after an investigation revealed corruption within the Erdogan government. In addition, Mr. Erdogan’s insistent railing against the “interest-rate lobby” and his bizarre insistence that higher interest rates lead to higher inflation certainly hasn’t helped the perceived risk of waning central bank independence.

    Meanwhile, in Russia, the government has ramped up security because of credible terrorism threats during the Sochi Olympics. This follows increased tensions in the North Caucuses, where Sochi is located, after two suicide bombers killed 32 people in Volgograd in December.

    South America has not escaped the increased perception of emerging-market risk, either. In Brazil, the government has fumbled the privatization of major infrastructure projects and the tender of the prized Lula Oil Field, amid massive street protests. Argentina’s problems have been compounded by poor policy choices and the mysterious October illness of its President Cristina Fernández de Kirchner.

    Perhaps, no emerging-market risk can top Thailand, whose currency the Baht, has fallen 5 percent since August. Massive protests in the capital, Bangkok, have pitted populist Red Shirts and Prime Minister Yingluck Shinawatra against pro-monarchy, urban groups called the Yellow Shirts. Protests have become so fierce that some fear the country could split apart.

    Increased risk perceptions shouldn’t be overlooked as emerging markets continue to struggle. To get back to growth, these economies should replace security concerns and political vendettas with sound macroeconomic policies and economic freedom.

    Posted in Economics [slideshow_deploy]

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