Developing economies including SA are up against it – what can we do to help ourselves?

The Wall Street Journal Online edition led on 23 January with the following report:

“Investors Flee Developing Countries Currencies in Many Emerging Markets Take a Pounding, Hit by Growth Fears

Investors dumped currencies in emerging markets, underscoring growing anxiety about the ability of developing nations to prop up their economies as they face uneven growth.

The Argentinian peso tumbled more than 15% against the dollar in early trading as the South American nation’s central bank stepped back from its efforts to protect the currency, forcing the bank to reverse course to stem the slide. The Turkish lira sank to a record low against the dollar for a ninth straight day. The Russian ruble and South African rand hit multiyear lows.

U.S. stocks tumbled as well, reflecting the world-wide pullback from riskier assets and continuing a weekslong struggle to regain the upward momentum seen at the end of 2013. The Dow Jones Industrial Average slid 175.99 points, or 1.1%, to 16197.35, the lowest close since Dec. 19.”

The Wall Street Journal (WSJ) indicated that the Turkish lira was the worst affected by the move out of emerging markets since 1 January, followed by the rand, down 3.54%, and the Russian ruble, also down 3.54%. Clearly emerging market economies (with a few exceptions, perhaps Mexico) are very much out of favour and may well stay out of favour if the current investor mood is sustained.

It was in fact not only a bad day for emerging markets and currencies it was a risk off day in the US with, accordingly, equities prices down and bond prices up. The risk on threat to emerging markets and their currencies including the rand can be easily identified. That is  more confidence in the US growth outlook (less risk attached to the prospects for the economy and the companies dependent upon it) leads to higher interest rates. These higher interest or discount rates have been mostly tolerated by the valuations attached to US equities, but unwelcome to emerging market equities as rising interest rates in emerging economies, led inevitably by the US rates, threaten the already unpromising growth outlook for emerging economies.

Clearly, as demonstrated yesterday, there is also a risk-off threat to emerging markets even as US rates move lower. The question then, to refer to the WSJ report, what can emerging market governments and central banks do to prop up their economies. Raising interest rates have done little to help support exchange rates. Intervening in the foreign exchange markets by selling US dollars has also not helped to stem the currency weakness. The global tide is flowing too strongly to be diverted and higher interest rates simply weaken domestic demand further. Higher interest rates put additional downward pressure on expected growth rates and undermine further the case for investing in the beleaguered emerging economies.

One sincerely hopes that the SA authorities have taken full notice of the unhappy experience of those emerging market central banks that, unwisely and unlike the SARB, have reacted in a highly activist way to the pressures in the currency and bond markets emanating from global investors and capital flows out of emerging economies and back to developed ones. Surely the best approach for an economy under stress is to allow a floating exchange rate to help absorb the pressures imposed by less sympathetic global investors; and to do what they can with monetary policy to help relieve some of the unwelcome pressure on domestic spending. While lowering short term interest rates in the circumstances of a sharp currency depreciation might be regarded as too sanguine an approach, leaving them on hold – that is doing nothing – would seem to be the best that can be done by a central bank in circumstances beyond the control of the monetary authorities.

For South Africa this means the mines, factories, hotels, restaurants and tour operators should stay open for business – or, better still, work overtime and double shifts where extra demands present themselves as they are doing most obviously for the SA hospitality industry where extra demand- encouraged by the weaker rand is leading to extra supply and the extra incomes and employment that comes with it.. The task for economic policy in SA is to make sure the export and import replacement-led growth happens and is encouraged. Sensibly reformed labour relations and policies for labour employed in mining and manufacturing, currently highly conspicuous by their absence, would be very helpful as would a highly supportive and well managed roll out of infrastructure; More success in these endeavours would be the best response to an increasingly sceptical global investor. Only faster growth or the prospect of faster growth will  attract more  capital to the businesses that drive the SA economy and would support the rand and by so doing also improve the outlook for inflation.

There is an important economic opportunity for the SA economy provided by the weaker real rand exchange rate (defined as an exchange rate that has moved significantly more than can be justified by relatively fast domestic inflation). The opportunity is for domestic producers, enjoying wider operating profit margins, to take a larger share of both the domestic market from importers and to increase their share of export markets through keener pricing on the local and foreign markets and  increased output and employment Such responses raise growth rates and by so doing are the only know method likely to impress foreign investors.