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Fragile economies under pressure as US recovery prompts flight of capital: So far this year $12bn of foreign money has fled the stock markets of emerging economies, and last week's Fed decision will accelerate that. Angela Monaghan looks at how further loss of western funds could affect six vulnerable countries

February 2, 2014

Angela Monaghan

The decision by the US Federal Reserve to further slow its programme of bond buying last week gave a clear signal of confidence in the world's largest economy. But the scaling down of monthly purchases, by a further $10bn to $65bn , put emerging market economies under renewed pressure: currency falls and a flight of foreign capital have already placed them on the "at risk" list. The spotlight is firmly on those emerging market countries that have large current account deficits, rely on overseas investment and have looming domestic elections. Investors pulled $9bn from emerging stock and bond funds last week alone, and so far this year $12bn has been taken out of emerging stock markets - close to the $15bn they lost during the whole of last year, according to figures from fund tracker EPFR Global. The "fragile five" - Turkey , Brazil , India , Indonesia and South Africa - are considered particularly vulnerable to an exodus of foreign capital as the prospect of higher interest rates diverts funds back to the US. Over the past week governments and policymakers in some of these threatened economies have been fighting back, with emergency policy decisions designed to put them ahead in the race to attract and retain foreign money. The fate of the fragile five is important, not least because they account for more than 12% of global GDP, and have contributed almost one-fifth of world economic growth since 2009. Ben Bernanke , whose tenure as Fed chairman came to an end on Friday, has argued in the past that emerging markets will ultimately benefit from policies that are designed to create a stronger US economy. He, along with the world's policymakers, will be hoping that the waves in emerging markets created by his final act will prove to be a bump on the road to global recovery, and not the beginning of a fresh crisis. Here we look at the problems that some emerging markets are facing. ARGENTINA Argentina is not a "fragile five" economy: its problems have escalated to such an extent that "fragile" does not go far enough to describe the situation. Analysts have estimated that inflation in Argentina was more than 25% in 2013, although the official rate is 10.9%. And it is expected to accelerate following the government's sudden relaxation of currency controls in January, prompting the steepest fall in the Argentinian peso since 2002, the year the country defaulted on its debt. The controls were relaxed in order to protect the country's dwindling foreign currency reserves: they fell below $30bn last month, making interventions to prop up the peso look increasingly unsustainable. The decision to stop interventions and loosen controls on trading pesos for dollars sent the peso's value plunging by more than 15%, threatening spiralling inflation and capital flight. Runaway inflation, rising crime and corruption have blighted the country, and the government has been accused of lurching from one policy to another, with little continuity. Two weeks ago the government under President Cristina Fernandez de Kirchner introduced new restrictions on online shopping, making it more difficult for Argentinians to spend their pesos on foreign goods. Each year, individuals would be allowed to buy items up to the value of $25 from abroad tax free, with a 50% tax imposed on each item thereafter. TURKEY Turkey had been slow to react to high inflation, with policymakers fearful that raising interest rates would hurt growth prospects. But following the lira's 17% fall against the dollar last year as the reality of the unwinding stimulus in the US hit home, the central bank called an emergency meeting last week and more than doubled rates, to 10% from 4.5%. The prospect of higher returns in the US has certainly hurt the lira, but domestic problems with a bribery scandal at the heart of the government have also undermined the currency. Turkish prime minister Tayyip Erdogan has maintained that the corruption investigation - which led to the resignation of three government ministers last month - was being driven by opponents intent on destabilising the economy before elections later this year. By making such a bold move on rates, Turkey has sent a signal that it is ready to fight for overseas capital. This appeared to work at first, with the lira strengthening when the rate increase was first announced; but it slid again within 24 hours as jitters returned. Meanwhile inflation was running at 7.4% in December, higher than in November and well above the central bank's 5% target. BRAZIL Near neighbour of Argentina and a prime candidate for contagion fears, Brazil has been steadily increasing interest rates in a battle against inflation and a weakening real - the currency which has fallen by about 15% against the dollar over the past year. Rates have risen by 3.25 percentage points over the past nine months, and the central bank's latest move was to push them up a further half-point, to 10.5%, in January. Economists are expecting another rise this month. But growth prospects are deteriorating and the International Monetary Fund has revised its 2014 growth forecasts downwards. Some analysts had expected the tightening of monetary policy to stop after the economy shrank in the third quarter of 2013 - for the first time since 2009 - and as political pressures intensify before presidential elections later this year. But the increases have continued, underlining some of the unenviable choices faced by the country's policymakers. Meanwhile, Brazil's role as World Cup host nation later this year is adding to its domestic woes, with recent protests against the tournament on the streets of Sao Paulo . Protestors are angry at the vast sums of money being spent on the event, which they believe would be better invested in improving the country's public services and infrastructure. INDIA Like several of its emerging market peers, India raised interest rates last week, in its case by a quarter-point, to 8%, in an attempt to rein in consumer price rises and prop up the currency. It was a surprise move by Asia's third-largest economy. Inflation has been slowing, but consumer price inflation remains high: it was close to 10% in December. The Reserve Bank of India has proposed a target of 4% inflation by 2016. Last week the Indian rupee dropped to its lowest level against the dollar since November, as the Fed's decision to further slow its bond buying programme sounded renewed alarm bells about the flight of capital. Raghuram Rajan , head of India's central bank, spoke out in opposition to the way the Fed has handled its decision to take its foot off the stimulus pedal, arguing that there needs to be greater policy co-operation between developed and emerging markets. The former IMF chief economist said: "We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country." SOUTH AFRICA A sharp fall in South Africa's rand to a five-year low against the dollar prompted a surprise 0.5-point increase in interest rates this week, to 5.5%. It was the first increase in five years, as Gill Marcus , governor of the South African Reserve Bank , acknowledged that a "new phase" of the global financial crisis was piling the pressure on emerging market economies. The extent of the challenge facing some was underlined when the rand actually weakened against the dollar following the rate rise. "While the Fed action signals a recovery in the US, and the UK economic outlook is also improving, it does not mean that the global financial crisis is over," Marcus said. Her message echoed that of India's central bank governor: recovery in developed economies is all well and good, but the risks to global stability have shifted, not disappeared. Economists believe the rise in interest rates in South Africa will not be the last. The rand is also more vulnerable to slowing economic growth in China , because of the knock-on effects of falling commodities demand and prices. South Africa's problems are not all externally driven, and a week-long strike by thousands of platinum miners seeking a doubling of their wages has further eroded investor confidence. The platinum industry is important to South Africa as a source of foreign exchange, and the industrial action has raised political tension in the runup to elections, expected in about three months' time. INDONESIA Indonesia resisted increasing interest rates for a second month in January, against a backdrop of stable inflation, at 8.4% in December. The central bank said it was closely monitoring the impact of the Fed's tapering programme, after growth in south-east Asia's largest economy slowed to its weakest rate in four years last year, with a poor trade position and the outflow of foreign capital taking their toll. The rupiah was the worst-performing emerging market currency in 2013, down around a fifth against the dollar. Analysts at Capital Economics said a rate rise for Indonesia could be on the cards though, if market turmoil escalates. For the time being, policymakers are adopting a wait-and-see approach, having taken action last year to defend the rupiah with a 1.75-point increase in rates since June. The country has suffered from widespread social unrest recently, after a sharp cut in government fuel subsidies, the first since 2008. Protesters blocked roads and clashed with police in the capital, Jakarta , in June last year after petrol prices rose by 44%, and diesel by 22%. Captions: A woman walks in front of a bureau de change in Buenos Aires, Argentina . Relaxation of credit controls this month has seen a dramatic fall in the value of the peso, while inflation is said to be running at 25%. EPA


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Source: Observer (UK)


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