January has always been a month associated with gloom. If anyone should be upbeat it ought to be the turkey having outlived the festive season, however the same can’t be said for the country. Turkey is currently experiencing intensive capital flight from its economy. As a consequence the government faces a fast falling currency that could spell all manner of complications for this developing nation.
However, more worryingly, this is not solely a Turkish phenomenon. The drain of speculative flow has been felt all over the globe by converging economies. The Chilean Peso has fallen 5 per cent since the beginning of the year and the South African Rand is at a five year low against the dollar. The concern is that as hot money contracts, developing economies will go cold.
What’s causing currency depreciation? It all stems from the financial crisis. In an attempt to handle the crash, central banks around the world slashed interest rates to new lows. The UK base rate still remains at record 0.5 per cent. Bound to fiscal austerity from public debt it was an attempt from the developed nations at damage limitation through monetary stimulus. Speculative flows of capital rushed to developing economies seeking high marginal rates of return. The result was a growing demand for currencies belonging to economies like the BRICs (a group of newly industrialised countries comprising Brazil, Russia, India, China and disputably South Africa, known collectively by the acronym of their first letters).
Appreciation in the value of these currencies ensued rapidly. In 2010 Brazil and other economies like the East Asian Tigers took measures to avoid their export slumps in competitiveness in the light of these ‘Currency Wars’. Four years on and how the tables have turned. The big economic players have started to wake and animal spirits have begun to stir again. Domestically UK growth rates have started to pick up. The National Institute of Economic and Social Research (NIESR) has predicted the economy will increase by 2.5 per cent in 2014. The US Federal Reserve has also started to rein in emergency policy measures. The overall consequence as described by Brazilian Central Bank Governor Alexandre Tombini is of “a vacuum cleaner in the developed world sucking money out of emerging markets”. As hot money is lured away from these economies, demand – and subsequently the value of these currencies – has plummeted.
Robert Peston, the BBC Business editor, has labelled the situation “the third horseman” and the inevitable third step in the “global financial meltdown” after the banking collapse and Euro crash. Overly pessimistic? Perhaps. However the effects of a falling currency can be real and painful. Turkey’s reaction to raise interest rates from 4.5 per cent to 10 per cent screams ‘panic’. Many members of the now-labelled ‘fragile five’ like Brazil, Russia and South Africa have already inflationary pressures. Currency depreciation would only exacerbate this further through imported inflation.
However, Elizabeth Johnson, director at Brazil Research Trusted Sources, evaluates the risk of the potential developing financial crisis differently. She insists that automatic stabilisers will kick in as the majority of developing economies employ a floating exchange alleviating any potential for concern. For export led economies like Brazil a falling exchange rate may even benefit its current account.
The severity of the problem is unpredictable and too early to call. Yet undoubtedly the rate of western recovery will be inevitably subject to the coming months of financial uncertainty in emerging markets. Is it time up for the developing world? Time will tell.