Great stuff here from Richard Koo of Nomura, who weighs in on the recent selling in emerging market currencies (and equities and debt).
His take: This is the price emerging markets are paying for not being more vigilant about hot money rushing into their economies after the Fed announced QE after the U.S. crisis. The emerging market, he argues, could have prevented the big rush of foreign cash through prudent measures, but that they opted not to take any pain, and now they’re paying the price for going the easy route.
He concludes that we’re now in for a “tumultuous new era” for emerging markets as QE gets unwound.
… the recent announcements would not have been necessary if these countries had taken advantage of these measures to restrict capital inflows from the US. They did not do so probably because restricting capital inflows is extremely unpopular. In nations attracting foreign capital, asset prices rise, people feel richer, companies are able to obtain low-cost funding, and inflation tends to be low with a stronger currency. Essentially everyone is happy but exporters, which suffer from a stronger currency. It takes a courageous policymaker to spoil that pleasant environment with capital controls, even if it is necessary for stable, longer-term economic growth. Therefore, the authorities typically preserve the status quo, in which “everyone is happy.”
Recent turmoil in emerging economies marks opening of tumultuous new era
Taiwan’s central bank has traditionally been quick to check on and if necessary restrict capital inflows, making its governor, Perng Fai-nan, an unpopular figure at certain foreign financial institutions. But it was only because the authorities kept such inflows in check that the Taiwanese economy escaped from the 1997 Asian currency crisis largely unscathed.
The lesson for emerging economies today is that in a world in which the industrialized economies are free to engage in quantitative easing at will, local authorities need to have the courage to restrict capital inflows or stop them altogether. It should also be remembered that the recent rise in US interest rates occurred simply because Mr. Bernanke said the Fed was considering scaling back its bond purchases. If the Fed were to actually discontinue its purchases under QE3 or sell the bonds in its portfolio, the resulting increase in rates would likely be much larger. In that sense, both the US and the emerging economies that will be affected as quantitative easing is wound down need to prepare themselves for a tumultuous era.
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