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Emerging Currencies

Forex Reserves Used to Prop Up Currencies

Over the last decade, the Central Banks of most emerging-market economies built up fantastic quantities of foreign exchange reserves, as a result of lopsided trade and current surpluses with foreign countries eager to invest abroad. However, declining commodity prices, sagging stock markets, and a global trend towards risk aversion have propelled investors to shift massive amounts of capital back into the industrialized world. As a result, these same Central Banks are drawing down on their reserves at a similarly rapid pace, in an attempt to shore up their ailing currencies. A cheap currency can be advantageous, especially during an economic downturn, since it makes exports relatively more competitive.

Mid-East to Form Monetary Union

It's all but official: five Middle Eastern nations will form an EU-style Monetary Union by 2010. Saudi Arabia, the United Arab Emirates, Qatar, Kuwait and Bahrain have signed a draft agreement to participate in a single-currency system, ostensibly to stimulate intra-regional trade. In fact, the Dollar's recent volatility is probably the driving force behind this initiative. All five countries currently peg or formerly pegged their currencies to the Dollar, which contributed to domestic inflation as the Dollar depreciated. If this arrangement is implemented successfully, it could provide the impetus for similar currency unions in Asia and Africa.

Asian Central Banks Defend Currencies

The foreign exchange reserves of Central Banks throughout Asia have been dwindling. The most plausible explanation is that they are using their reserves to intervene in forex markets on behalf of their respective currencies, many of which have fallen dramatically in 2008. The Korean Won, Thai Baht, and Filipino Peso, to name but a few, have each dropped around 15%. While it may seem futile for Central Banks to continue intervening, it is important to remember that the goal may be to slow -not halt- the decline of the currency. In fact, given the current economic climate, most of them will tolerate currency weakness, in order to boost the competitiveness of their export sectors. Reuters reports:

Australia, New Zealand to Lower Rates

I won't lie; the Forex Blog is admittedly Dollar-centric, in that developments in forex markets are usually assessed relative to their projected impact on the US Dollar. Sometimes, we forget that their are other currency pairs that move irrespective of the Dollar. Take the Australian Dollar and New Zealand Kiwi, for example. As both currencies are backed by high interest rates, they have benefited equally from the carry trade and as a result, they behave quite similarly. Combined with the fact that they are practically neighbors, it's easy to forget that there are unique circumstances that weigh separately on them.

Inflation Drives Latin American Currencies

While not yet in the same league as other popular emerging market currencies, the Brazilian Real and Mexican Peso are sure to join their ranks soon; both currencies have risen markedly over the last few years, and have performed especially well in the year-to-date. They have been propelled by interest rates that are generously high, especially compared to those of the US and EU. Brazil's benchmark rate currently stands at 13%, while Mexico's equivelent rate is slightly lower, at 8%. In fact, interest rates are quite high throughout the region, including in Peru and in Chile.

Money Flows Back into US

In historical periods of financial crisis, where did investors turn?

Emerging Markets: To Hedge or Not to Hedge?

2008 has witnessed an explosion of volatility in emerging markets, affecting both debt and equity securities. Fluctuations have been especially dramatic in the forex markets, compounding the turmoil and skewing returns for foreign investors. The South African Rand and Brazilian Real, for example, have moved so violently that for both countries, a 10% gap distinguishes the returns earned by local and foreign investors. As a result, some institutional investors are re-examining their hedging strategies with regard to emerging markets. According to experts, currency hedging among equity investors is still rare because it is expensive and often complex. If hedging is undertaken at all, it is usually outsourced to a third-party.

Indian Rupee at 14-Month Low

The Indian Rupee has fallen to a 14-month low as a result of the sagging Indian stock market and surging inflation. Foreign investors have withdrawn $5.7 Billion from the Indian stock market in the first half of 2008, reinforcing the 30% drop in stock prices that occurred over the same time period. Meanwhile, the nation's benchmark inflation rate has risen to the highest level in nearly 13 years, and investors are clamoring for the Royal Bank of India to do more. The RBI has already raised interest rates as well as intervening on the Rupee's behalf in forex markets, as indicated by data on the RBI's foreign exchange reserves. Both moves were explicitly aimed at combating inflation, but may also carry the unavoidable consequence of stunted economic growth.

Rouble: The Next Reserve Currency

Apparently, Russia has aspirations to turn its currency, the Rouble, into an international reserve currency. Moreover, according to an official with the International Monetary Fund (IMF), this plan is not that far-fetched. Despite soaring inflation and political oppression, Russia's economy is forecast to grow at 8% for the next two years, due primarily to soaring natural resource prices. By its own admission, Russia needs to diversify its economy without inhibiting growth, strengthen its financial system, and conduct monetary policy with price stability in mind. These ambitious steps, combined with continued economic growth, would position the Rouble to be a stable and viable alternative to the Dollar, especially on a regional basis. The Guardian reports:

Vietnam Devalues Dong

The Central Bank of Vietnam has effectively devalued its national currency, the Dong, to bring it in line with market fundamentals. Pressure had been building under the Dong due to soaring inflation, currently estimated at 25%. While 2% devaluation was small in itself, it caps a 5% drop in the currency since March 25. In addition, the move showed just  how seriousness Vietnam is about restoring macroeconomic stability. Unfortunately, Vietnam's balance of trade is probably deteriorating faster than it can be repaired, which means the Dong may slide much further. The black market exchange rate is estimated at 18,000:1, compared to the official rate of 16,461:1. Non-deliverable forward contracts imply a 30% depreciation in the Dong in the next year. The Guardian reports:

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