A Forex View From Afar

Wrong Time to Catch Up for Emerging Economies

In the economic world, the term “catch up” describes an emerging country’s economy that tries to reach the standards of an industrialized economy.

When the small “insular” economies are catching up, deficit is starting to build up, threatening to throw the country into a burden of debt. However, this debt is what will help the economy progress, so it is often called a “necessary evil”.

The problem is, these days the emerging countries need inflows of cash in order to support the debt, something that is not happening now. The credit crunch, among other things has completely dried up the credit lines. As money leaves the emerging economies, usually for the safety of the bond market, the countries’ currency declines and the debt size increases, becoming unsustainable.

These effects could already been seen in countries were the deficit was built on foreign currencies. First, it was Iceland, which the entire financial system had only foreign owned debt. Now it is Hungary’s turn, which also has an large amount of their debt in foreign currencies and which has also helped some bank-runs after rumors emerge. In an attempt to save the local currency, the Hungarian forint, the central bank unexpectedly raised interest rates 300 basis points, or 3 percent to 11.50%. Just in the last month, the forint declined 15% compared with the euro and a massive 30% compared with the U.S. dollar. Intra-day volatility has been extremely high during this period.

At the start of the credit crunch, many analyst including myself, thought the crisis will have somewhat of a positive effect for the emerging economies, which were in danger of overheating due to the high inflation levels. However, something good quickly turned in a very strong danger and now, after the recent developments in the emerging economies (Argentina close to a default, lowest growth in recent years in China, and high depreciations in most emerging country’s currency) it seems the IMF will have some hard work ahead. To some extent, if the Fed bails out banks, the IMF bails out whole economies and countries.

If you are into longer-term trades, it is worth a look at some currencies from the emerging block. You can never tell when a speculative attack will come…

No Comment | Posted in » economic preview, forex