BRICS suffer from Fed funding fallout

Whilst most of the recent media and political attention has been focused on conflict in Syria, there is another war being waged at the moment. I am not talking about the “currency wars” which captured much attention during the midst of the GFC.

No, I am talking about the war on emerging markets and the so called BRICS nations – Brazil, Russia, India, China and South Africa – which, with the exception of China, have seen some massive capital outflows in recent times.

Currencies such as the Indian rupee (INR) have been hit hard, with the INR depreciating almost 30% against the Greenback. The recent run began when the US Federal Reserve Bank announced its plans to unwind the USD 85 billion a month it currently spends to buy economic stability, which benefits everyone. So the Fed, as it is commonly referred to, has as a consequence of its actions created some issues in some of these other economies.

What about me?

There has been a chorus of concerns in recent weeks with Brazil in particular voicing its opinion on the negative consequences of the Fed’s unconventional policy, as has Mexico amongst others.

There is an argument supporting the view that the initial Fed policy of setting interest rates at 0% and printing money benefited some of these emerging markets, and they knew it wouldn’t last forever.

When the Fed’s second and third rounds of quantitative easing programs were rolled out, those investors prepared to take some risk moved capital out of the US into these emerging markets, providing a boost to their economies.

Many are also pointing to the fact that the negative economic consequences the BRICs are experiencing could have been avoided. The massive inflow of liquidity over the last few years was an opportune time to put in place some structural reforms and their reluctance to do so has, in part, led to their current predicaments.

The recent weakening in emerging market currencies could also be considered a correction to previous imbalances and there are many benefits of a weaker currency. However, there is a point where stability needs to be restored before it becomes a major problem.

Imbalances to widen

Judging by the reaction of some US policymakers to the objections from emerging market officials, it does not appear as though the Fed is too concerned at this point. They have taken the position that they are limited by law to focus only on domestic objectives, and as such, they can’t do anything about the impact on other economies.

In my view, the flow of funds away from the emerging markets back into developed nations such as the US is still only in its relatively early stage and is set to persist for quite a while. As a consequence, I expect to see these currencies continue to weaken.

Until the point where officials in these emerging nations are forced to act directly via some form of intervention, or the market naturally moves into some form of equilibrium, there is likely to be some further depreciation on the currency front.

Jim Vrondas is chief currency and payment strategist, Asia-Pacific at OzForex, Australia’s leading international money transfer service.