Central Banks in Emerging Markets Take Action

Following a bout of market turmoil that’s weighed on their currencies, central banks in emerging economies are moving quickly to contain the damage.

Late Tuesday, Turkey’s central bank raised its key interest rate to 12 percent, from 7.75 percent, to try to stave off inflation and support the national currency, which has fallen sharply in recent weeks.

The decision was taken at an emergency meeting the central bank called for after the currency, the lira, hit a record low.

The People’s Bank of China on Tuesday injected more money into the country’s financial markets to ease strained credit conditions. India’s central bank unexpectedly raised interest rates to prop up its ailing currency.

“The market is expecting a lot, and should the central bank fail to deliver, we expect another round of lira weakness,” said Christian Lawrence, associate director of foreign exchange strategy at Rabobank International.

Much of the turmoil in global financial markets over the past week has been due to developments in emerging economies. Argentina suffered the most eye-catching fall in its currency, amid concerns over the government’s economic policies.

However, there are broader worries that emerging markets, which have been some of the fastest-growing in recent years, are particularly vulnerable at the moment. Among the key risks are China’s economic slowdown and the U.S. Federal Reserve’s decision to scale back on its monetary stimulus.

The Fed is expected to announce another $10 billion reduction in its monthly bond purchases, to $65 billion. For the past few years, the Fed’s stimulus has helped shore up financial markets around the world.

The stimulus had the effect of lowering Treasury interest rates, pushing investors to seek out higher returns in fast-growing emerging economies like India and Brazil.

Now that the prop of the stimulus is being taken away and the interest rates on Treasurys are starting to look more attractive, a lot of the money underpinning emerging markets is flowing out. That pressures currencies, as evident across the emerging world – notably India and Turkey – over the past few weeks.

In a move to shore up its currency, the Reserve Bank of India raised its benchmark interest rate by a quarter of a percentage point, to 8.00 percent. Though it justified the move in terms of keeping a lid on inflationary pressures, protecting the rupee is widely considered to have been a key motive. Following the move, the rupee rose 0.7 percent, to trade at 62.66 rupees to the dollar.

“Although it went unmentioned in the RBI’s statement, the recent sell-off in emerging market assets may have played a part in today’s decision,” said Miguel Chanco, India economist at Capital Economics.

That said, Chanco noted that the rupee has been a little more resilient of late, largely because of a substantial fall in the country’s current account deficit – the difference between what it exports and imports.

After the Argentine peso, the emerging-market currency that has performed worst this year has been the Turkish lira. After Turkey’s central bank raised its key rate Tuesday, it said its goal is to lower the country’s inflation rate, which reached 7.4 percent in December. In a statement, it forecast that inflation will fall to its 5-percent target by mid-2015.

Ahead of the meeting, the lira stabilized, trading 0.1 percent higher, at 2.26 lira to the dollar. On Monday, it fell to a record low of 2.39 lira to the dollar before the central bank said it would hold the emergency meeting.