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Monthly Report - Focus
Emerging currencies: overly punished?

Over the last few months, the debate regarding the route back to monetary normalisation in the USA has been a source of volatility for global markets in general and for emerging markets in particular. One of the most visible consequences of the deterioration in the financial environment in the emerging block has been the sharp depreciation recorded by their currencies, both against the dollar and also against the euro. It should be noted, however, that the extent of these depreciations varies depending on the country. Some of the hardest hit are Brazil, India, Indonesia, Turkey and South Africa («BIITS» or «the fragile five»), while others have hardly suffered at all. The Focus «Emerging countries in trouble: who is who?» considers the macroeconomic aspects associated with this performance. Also of use in clarifying the issue is an examination of the scale of the depreciation related to the equilibrium exchange rates. In other words, calibrating whether these have helped to correct, accentuate or create deviations from the equilibrium level.

Although there is no standardised methodology to determine a currency's proper or equilibrium value,
the procedure of «current account regression» employed by the International Monetary Fund (IMF) is of great use. This model can be split into two stages. Firstly, the «equilibrium current account balance» or norm is estimated based on a set of macroeconomic and financial variables that are deemed relevant by economic theory and the difference or gap is calculated between this estimate and the «actual current account balance» (deducting the cyclical component). The second stage consists of estimating the «real effective exchange rate» that would correct this gap. This helps to determine whether a currency is over or undervalued compared with its trading partners and to what extent. The most recent deviation figures with regard to the equilibrium exchange rate provided by the IMF refer to 2012.

Before analysing the trend in the BITTS currencies between January and August 2013 (the peak of the turmoil), two important points must be made. Firstly, the nominal depreciation of the currencies in question against the dollar may differ considerably from those measured using the real effective exchange rate and they must therefore be taken merely as a guideline. Secondly, this depreciation has partly reversed since the beginning of September, especially after the Fed's decision to delay its reduction in monetary stimuli. Nonetheless, this does not essentially alter the underlying message. The cases of India and Indonesia show similarities and differ slightly from those of Brazil, South Africa and Turkey.

In the case of the Indian rupee, turbulence in foreign exchange markets led to 26% nominal depreciation against the dollar from the start of the year up to the end of August, and 15% for the Indonesian rupiah. Given the equilibrium level set by the IMF, 2012's current accounts were in line with their equilibrium levels and, by extension, their real effective exchange rates did not differ from their appropriate value. It therefore seems that the depreciation occurring over the last few months has been excessive in both cases.

For Brazil, Turkey and South Africa the figures provided by the IMF warn of an excessive current account deficit and overvalued currencies in 2012, which have tended to correct this year. In the first two cases the current account imbalance was approximately 2% of GDP, which in real effective exchange rate terms would be the equivalent to a 10%-15% overvaluation for the Brazilian real and Turkish lira. The depreciation accumulated by both currencies against the dollar up to August was precisely of this size. South Africa had a more worrying imbalance in terms of its current account deficit, very close to 4%, suggesting that the rand was overvalued by between 15% and 20%. It is therefore not surprising that the rand has depreciated more quickly, sharply and persistently, easily exceeding 20%.