beyondbrics

By Valentina Romei and Barney Jopson

The narrative of the “currency war” in emerging markets is pretty straightforward: “hot money” flows in; currencies appreciate; exporters suffer; policy makers retaliate. But the realities on the ground are neither simple nor uniform.

No clear correlation has emerged between the extent of currency appreciation and the vehemence of authorities’ reaction to it. This weeks beyondbrics chart helps to explain why that might be by plotting oft-quoted figures on appreciation against less-studied levels of export dependence.

Specifically, the chart shows the appreciation of 11 countries’ currencies since the start of 2009 against the value of their exported goods and services as a proportion of gross domestic product.

The connection is this: the more a currency strengthens, the harder it is for manufacturers to compete in the international market on price, and in their domestic market against a flood of cheap imports.

In the chart’s lower right corner, one of the outliers is Brazil. Its government has led the pack in introducing capital controls to stem the appreciation of its currency, the real, and one axis of the chart underlines why: the real has appreciated by around 38 per cent since January 1, 2009.

Yet Brazil’s economy is less dependent on exports than every other emerging market on the chart. They are equal to just 10 per cent of the country’s GDP (though they do not actually contribute 10 per cent, because the trade element of GDP reflects the difference between the value of exports and imports).

Tony Volpon, head of emerging market research for the Americas at Nomura, reminds beyondbrics that this is because Brazil is a huge continental economy whose diversity makes it more akin to the US than to export-dependent China (which does not appear in the chart because Beijing does not let its currency move freely).

So why are Brazil’s policy makers so sensitive to the currency? Domestic politics has something to do with it. Both the new president, Dilma Rousseff, and her predecessor, Luiz Inácio Lula da Silva, are from the left wing ranks of the Workers’ Party, which has an instinctive sympathy for the manufacturing sector and its labourers.

Chile has seen less currency appreciation, but depends more on exports, which are equal to nearly 40 per cent of the country’s GDP. Unwilling to tolerate further strengthening of the peso, earlier this month the central bank said it would spend up to $12bn this year to curb its strength.

Felipe Larraín, Chile’s finance minister, explained: “We are supporting domestic producers, our exporters, in the farm as well as industrial sectors who depend on exchange rates.”

South Africa does not fit into this narrative. The rand has appreciated almost as much as the real – driven by record inflows into the sovereign bond market – and triggered yelps of pain from exporters and trade unions. But the South African authorities have been relatively restrained: rather than trying to limit inflows, the most they have done is loosen restrictions on outflows.

More comprehensive measures have been wheeled out in Asia, where a cluster of countries (on the upper left side of the chart) have long embodied export dependency. Their real export growth has slowed since the start of 2010.

The 12 per cent appreciation of South Korea’s won over the past two years is not huge, but it has a huge impact on the Korean economy because exports are equal to nearly 50 per cent of GDP.

That’s why Korean policy makers have resorted to a series of measures, including (unconfirmed) intervention in the forex market, a withholding tax on foreign investors’ earnings from sovereign bonds, and new equity derivatives controls to deter speculation.

Still, experts class these measures as mild compared to what’s gone before.

In a bigger bind is Thailand, whose currency has appreciated even further than Korea’s, and whose economy is even more reliant on exports. It’s also introduced a withholding tax on bond earnings. But memories of a botched previous episode may explain policy makers’ reluctance to do more: in 2006 they retreated abruptly from plans to impose a 10 per cent withholding tax on foreign equity investment after it triggered a stock market rout.

Then there’s Malaysia. The value of its exports is extraordinarily high, equal to over 90 per cent of GDP, and the ringgit has appreciated by as much as many of its Asian peers.

But one Malaysian minister has told beyondbrics the country has “no intention of introducing capital controls in the short term”. He didn’t explain why, but Malaysia has been stung by capital outflows before and is eager to attract more foreign investment. So it probably doesn’t dare do anything that could turn off investors.