'Fragile five' buckle under pressure
The cutting back of the supply of cheap money to the United States banking system (known as tapering) has begun, bringing turmoil to markets internationally — particularly emerging markets.
Turkey this week unexpectedly raised interest rates by a whopping 5.5 percentage points.
Money that has flowed to emerging markets in search of higher yields is being withdrawn in expectation of higher rates in developed markets.
The reversal of flows has been hammering emerging market currencies, including the rand, and stock markets.
Reserve Bank governor Gill Marcus this week unexpectedly announced an interest rate hike of 50 basis points, the first increase since rates started declining in October 2008.
In increasing the repurchase (repo) rate to 5.5%, the Reserve Bank's modest hike will translate into an extra R580-million a month for South African consumers to pay, or R7-billion a year, given that the National Credit Regulator last calculated household debt at R1.4-trillion.
Still, it's small change when compared with the impact on Turkish consumers — the hike on Tuesday saw the lending rate increase by 425 basis points from 7.75% to 12%.
South Africa appeared to be an island of calm in an emerging market storm, with rates holding steady for 18 months despite inflation being at the upper end of the target range, an ever-widening trade deficit and the rand's downward spiral. But this week Marcus, who swopped her trademark kaftan for a pants suit, had to face the facts.
But a few hours after her announcement, the US Federal Reserve said it would cut its bond purchases back by a further $10-billion, from $75-billion to $65-billion, which caused the rand to spike to R11.38 against the dollar early on Thursday morning — its weakest level since mid-2008.
South Africa was the last of the so-called "fragile five" to raise rates. Just hours before the Reserve Bank's move, Turkey surprised the market with a jump from 4.5% to 10% in the repo rate and from 7.75% to 12% in the overnight lending rate.
A day before that, the Reserve Bank of India raised the benchmark repo rate from 7.75% to 8%.
In November last year, the Bank of Indonesia raised the overnight lending rate by 25 basis points to 7.50%. Brazil has raised interest rates by 325 basis points since April last year to reach 10.5%.
The Federal Reserve announced in December it would start reducing its monthly bond purchases from $85-billion a month to $75-billion.
Cutting back bond buying
On Wednesday, its open market committee announced it would cut back bond buying to $65-million a month. In its announcement, the Fed made no mention of the strain it was putting on emerging markets.
"The Fed has lost some credibility," said Benoit Anne, the head of emerging market strategy at Société Générale.
He said there have been concerns about the speed at which the Fed would withdraw the stimulus from the market, despite assurances it would be slow and steady.
Although US tapering may have been the start of it, analysts say it is the slowdown in China that is having the largest impact on developing economies.
"The tapering story is probably being overemphasised. The Fed is the global monetary superpower but, increasingly, the People's Bank of China is the superpower [for emerging markets]," said Lars Christensen, the head of emerging markets research at Danske Bank.
He said news coming out of economies such as China has increased concerns over emerging markets. For developing countries whose economies are dependent on mining and other commodities, China, the largest buyer of many of these, is significantly more important than the Fed, he said.
The gradual tightening of monetary conditions in China has also led to increasing distress in the Chinese money market and has affected export expectations, Christensen said. As a result, South Africa is facing a negative demand shock.
Analysts agree that the South African Reserve Bank has been more reserved than most. The Turkish rate hike was "very aggressive" and an "insane overreaction to sell-off in the currency", Christensen said.
Peter Attard Montalto, an emerging markets economist at Nomura, said the difference between South Africa and other distressed emerging economies is that it does not really have flow issues.
"The current account remains funded and there is no mass flight for the exit by investors or huge forex liabilities that put the economy under stress … this allows monetary policy to be boring and orthodox."
Wayne McCurrie, of Momentum Wealth, said there are valid reasons why the rand will continue to weaken, such as the persistent current account deficit.
"The only balancing factor is the value of your currency. It has to naturally weaken to try and improve that situation. It should almost be accepted as a norm," he said.
Kevin Lings, the chief economist at Stanlib, said that quantitative easing (QE) in the US allowed interest rates to stay low for longer.
"This is because it allowed us to fund the growing current account deficit. Without QE, we would probably not have experienced as much capital inflow and the current account would not have ballooned."
McCurrie said that inflation also guarantees rand weakness, which, despite being under control, is higher than that of our trading partners.
But by mid-January, the rand had slumped by 19% over the previous 12 months.