EMERGING MARKETS
prolonged interval of nuanced adjustment. During this phase, EM fund managers move to re-balance exposures to optimise their portfolios for the change in environment and to take advantage of opportunities to purchase underpriced EM assets that may have been left in the wake of the initial flood of selling. Indeed, it helps to look at the whole period between 30 April 2013 and 31 January 2014, as well as to separate the EM FX performance into three distinct periods. Among spot exchange rates for the EM nations shown in Figure 1, the representative move over this 9-month interval was a depreciation of between 9% and 21%, with Argentina being an outlier with significantly more depreciation
which reflects the tight clustering of the EM currency movements that garnered the contagion label. As we have argued, though, the QE “Taper Talk” may have been a spurious association since there were also major political issues and disturbances around the EM world at the time. The middle period, from 6 July through 31 December 2013,
saw less association, with the dispersion measure rising to 5.4% (excluding Argentina and China). This was the interlude where country differences again mattered more than contagion. EM FX rate movements varied over a wider range, with some currencies stabilizing, such as the Russian ruble (+1.4%) and the Mexican peso (+0.3%), while other currencies depreciated significantly, such as the Indonesian rupiah (-18%). Then, in January 2014, EM FX movements again saw strong associations. Our dispersion measure fell to a low of 2.1% (excluding Argentina and China), indicating a very tight clustering during this brief period. Note that the contagion periods are relatively short, one or two
... we believe that improvements in market
(-35%), and the Chinese RMB representing the other extreme with a small appreciation (+0.3%). A quantitative measure of
dispersion over the whole period is to use the standard deviation of the percent changes in the EM spot FX. For this measure, a standard deviation
of 0% would indicate
perfect correlation – they all moved together and by the same amount. Higher standard deviations indicate more dispersion and less correlation in the movements. For the countries in our sample (See Figure 1) versus the US dollar, the dispersion measure was 8.4% for the whole period. If we take out our two outliers, Argentina and China, the dispersion measure falls to 4.5% for the “clustered” set of EM currencies. In the shorter contagion periods this measure of dispersion was even lower, reflecting a greater association of the EM FX movements and tighter correlations. The first round of contagion
was associated with the Fed’s QE ‘Taper Talk’ and ran from 30 April to 5 July 2013. During this period, the standard deviation of the EM FX movements was close to 3.0%, (excluding Argentina and China),
68 March 2014
liquidity and more active trading in EM currencies may help alleviate contagion episodes ...
months, and then country differences start to resurface quickly. While we will discuss this topic again in the final section, we believe that improvements in market liquidity and more active trading in EM currencies may help alleviate contagion episodes, although the situation may get more focused on the specific countries in the headlights of perceived increased political risks.
Three Case Studies To highlight the differences among EM countries, we want to look at three of the largest – Brazil, India, and China. During our period of interest, 30 April 2013 through 31 January 2014, the Brazilian real fell 17%, and the Bovespa Index fell 15%. Similar to the Brazilian real, the Indian rupee depreciated 14%, but India’s SENSEX Index gained 5%. In China, which limits currency volatility, the RMB appreciated nearly 2%, yet the Shanghai Composite Equity Index fell over 6% over the period. What happens to the currency does not necessarily happen to the equities, underscoring the need to analyze each country separately.
Brazil Brazil is an interesting case in the EM FX and equity turmoil because they had started their interest rate tightening cycle just ahead of the contagion episode. Even so, the Brazilian real was hit fairly hard, as noted, falling sharply over the period in question. The central bank commenced tightening short-term rates in April of 2013, and overall, the SELIC base overnight rate has been raised seven consecutive times, from 7.25% to 10.5% – an aggressive move by the central bank. The original rate moves may have been motivated more by inflation fears, while subsequent rate moves were more motivated by the currency decline, which was also perceived as raising potential inflation pressures down the road. Also, and by way of contrast, while Brazil saw its short- term interest rate rise, during the same period, Mexico actually made a small cut in rates. Yet, the Mexican peso was modestly more stable, falling a little less than half of the ground lost by the Brazilian real.
EM economies are typically not as interest rate sensitive as
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