Saving savings to save the lira
Now that the lira and other emerging market (EM) currencies have somewhat stabilized, at least for the moment, it may be useful to try to understand why some underperformed, while others overperformed, peers.
Five are especially worth mentioning. The Brazilian real, South African rand and Turkish Lira were especially hard-hit this year. On the other hand, the Indian rupee and Indonesian rupiah have held relatively well. This difference was evident last week as well. After the Fed meeting on March 18, all EM currencies immediately strengthened against the dollar, but the next day most continued their slide against the greenback. The rupee and the rupiah still gained.
Politics definitely played a role. While President Recep Tayyip Erdoğan’s tirades against the Central Bank shaped the lira, Brazil was shaken by a corruption scandal. But it would be incorrect to put all the blame there. The consensus explanation is that the currencies of countries with the largest current account deficits were hit the hardest. After all, deficits need to be financed from abroad. U.S. monetary policy, which is also strengthening the dollar, has implications on capital flows to EMs.
This reasoning makes sense, but it is not completely supported by the data. After all, while Turkey and South Africa are expected to end the year with the first and third largest current account deficits, according to the IMF’s latest projections, Indonesia’s projected deficit is not that different from Brazil’s – and India is not that far behind.
In a recent research note, economics consultancy Capital Economics argues that we should be worried about savings rates rather than current account deficits. They show that “the hardest hit EM currencies over the course of this year have been those of the economies with low domestic savings rates.”
This should not come as a surprise. After all, national accounting identities dictate that a country’s current account deficit is equal to the sum of its savings –investment and budget balances. Therefore, as in the case of Turkey, low savings rates usually translate into large current account deficits.
But I like the emphasis on savings rates: For one thing, it goes to the core of the problem. After all, a low-savings country may not be running a current account deficit if investment is low as well, but it will not be able to grow, either. Capital Economics argues that such countries are also more likely to hit capacity constraints and end up with inflation. While I have not seen any empirical paper establishing such a relationship, Brazil, South Africa and Turkey have the highest inflation rates in the EM world.
More importantly, “low savings rates are a symptom of deeper economic malaise.” The “fragile three” have been delaying much-needed economic reforms. On the other hand, “it’s worth noting that the Indian rupee and Indonesian rupiah have performed much better during the latest sell-off than they did during the taper tantrum in 2013 which, in part at least, appears to be due to the election of governments prepared to push through structural reforms.”
There is another explanation. I visited both Brazil and South Africa recently. No wonder their currencies are suffering. After all, I am not only an exposed traitor and enemy of Turkey, but also a self-declared member of the interest rate lobby.