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Explainer: What's Driving Turbulence In Emerging Markets?

A woman passes by a sign displaying ruble exchange rates in Moscow. The Russian currency recently fell to its lowest level against the US. dollar in almost five years. (file photo)
A woman passes by a sign displaying ruble exchange rates in Moscow. The Russian currency recently fell to its lowest level against the US. dollar in almost five years. (file photo)
By Charles Recknagel
If there is one common denominator these days in emerging markets, it is turbulence, with many of these countries' economies having to contend with sliding currencies and stockmarket volatility. Here are five things to know about what's behind the turmoil.

How widespread is the turbulence in emerging markets?

Since the start of the year, investors have been fleeing emerging markets worldwide amid concerns about faltering economies and political unrest.

The turbulence is not felt in every emerging market but is widespread enough to talk of a global phenomenon.

Last week offered particularly dramatic examples. On January 24, Russia's ruble fell to its lowest level in almost five years against the US. dollar, while Turkey's lira fell by 1.6 percent in a single day.  At the same time, South Africa's rand slid to its weakest level since October 2008. And even Mexico’s peso, one of the stronger currencies in emerging markets, fell to its weakest level against the U.S. dollar since June.

What is behind the problem?

Neil Shearing, chief emerging markets economist at London-based Capital Economics, says part of the trouble is declining investor confidence due to two reasons.

"The first has been renewed concerns about the direction of the Chinese economy and the possibility of a hard landing there," he says. "The second has been a renewed focus by investors on tapering by the Fed [the U.S. Federal Reserve] and the shift towards tighter monetary policy in the United States."

Worries about Chinese economic growth -- seen as an engine for many other emerging markets -- have increased after China showed a slower than hoped for growth rate in December. That frightened international investors with holdings across Asia, prompting some to pull their capital by selling off stocks and divesting local currency.

Meanwhile, the Federal Reserve, the U.S. central bank, has announced plans to scale back and eventually end its "quantitative easing" policy of injecting money into the American economy -- a policy that until now has provided a huge pool of cash for lending, including the provision of loans to emerging countries. International investors fear that shrinking this pool will now increase financial problems in countries like Turkey, Brazil, India, South Africa, and Indonesia, which rely on easy foreign credit to maintain otherwise unsustainably high government deficits.

Are local conditions also causing problems?

Yes, and in some countries they, much more than global factors, are behind the difficulties.

"The key thing in all of this is to differentiate between different emerging markets and the vulnerabilities facing them," says Shearing. "So, for example, the biggest challenge facing Russia is ultimately trying to find new sources of growth, it is not about Fed tapering."

The Russian ruble has lost some 10 percent of its value this year over concerns about lackluster future economic growth. Russian Economic Development Minister Aleksei Ulyukayev says Moscow may postpone plans to float the ruble by 2015 as planned.

Turkey is in trouble for a different reason. Its lira has tumbled some 20 percent since a corruption investigation targeting close allies of Prime Minister Recep Tayyip Erdogan became public on December 17 and Erdogan hit back by firing scores of prosecutors and police involved in the probe, shaking confidence in the government. Turkey's central bank hiked interest rates on January 29 in a bid to support its currency, just as South Africa and India also tried to shore up their currencies this week.

Ukraine's hryvnya has slipped some 3 percent since early December under yet different circumstances. The country's central bank is letting the currency devalue slightly in hopes of kick-starting the ailing economy despite continuing street protests over Kyiv's decision to spurn closer ties to the EU.

Could some countries emerge stronger from the crisis?

Emerging market countries whose currencies are now losing value can hope that the devaluation of their currency will help make their exports cheaper, helping put them back on the road to growth in the future. Turkey's steel exports, for example, have benefitted from the weaker lira, while Ukraine, another major steel producer, hopes weakening the hryvnia will equally boost its exports.

But the current crisis is also exposing fundamental weaknesses in some emerging countries' economies that will be difficult to fix. Countries with large government deficits now will either have to find new sources of loans, new ways to generate government revenue, or adopt unpopular austerity measures if they are to regain stability.

Much will depend on how the economic recovery in Western markets goes. The hope is that as the Western countries continue to recover from the global financial crisis, they will buy more exports from emerging market countries, helping them ease their current-account deficits and making them less dependent upon foreign capital.

Have we been here before?

Yes, in 1997 with the Asian financial crisis, followed in 1998 by the Russian ruble crisis.

The Asian financial crisis, like the turbulence in emerging markets today, came as previously readily available Western credit -- largely from the United States -- began to dry up, causing Asian economies to slow down.

That, in turn, sparked the Russian ruble crisis as the drop in Asian demand for crude oil and metals severely reduced Russia's exports and strained its foreign exchange reserves. By August 1998, the Russian government had to devalue the ruble, default on domestic debt, and declare a moratorium on payment to foreign creditors.

Emerging markets are still a long way from repeating that catastrophic scenario. But both the Asian crisis of 1997 and the current turbulence are a reminder of how economic trouble in one part of the world can spell trouble in another, even when the local causes are quite different.

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