BRICS Currency Crisis Is Looming

By: Andrew_McKillop

FORGET THE DYING DOLLAR
Federal Reserve taper-down is becoming almost certain, and with it higher interest rates. One direct result is a strengthening US dollar. The US trade deficit, notably due to fast-growing shale oil production trimming imports and sufficient shale gas output to support LNG export trade, is likely to go on shrinking, strengthening the dollar. The myth of an “always weakening dollar”, which was a reality for years, now has realworld Emerging economy rivals actively slumping towards national currency crises. This concerns major “BRIC's” economies – unlike the 1997-98 Asian NIC crisis.

The Federal Reserve’s ultra-loose monetary policies “diluting the dollar”, a slow-growth economy eroding the value of the greenback, and endless chat about the dollar losing is status as world reserve currency due to raging deficits and out-of-control budgets were always on hand as reasons to bet on dollar weakness. This has changed for reasons as basic as the USA's energy transition – and huge inflows of capital to play US equity markets as they tear upward. Since first-quarter 2013, data indicates that net equity flows into the US could be running at $150 billion-a-year, to compare with 2011's annual net outflow of $47 billion, followed by a $62 billion inflow in 2012.

To be sure, these “hot flows” can reverse in an instant, but the safe-haven status of the dollar also has to be added on the positive side. Where none of these factors safeguarding currency strength are in play – when deficits grow, inflation soars and the economy slows – the currency can only weaken.  This is the fate now assailing the Indian rupee which has depreciated by 45% in the past two years against major currencies led by the dollar, and hit a record low against the US dollar this week.

ASIAN CRISIS REVISITED
Betting on the Indian Sensex stock market gauge continuing to tank is an easy bet. Indian bond yields are nudging 10% a year, inflation is soaring, capital is flooding out of the country. Supposedly anecdotal evidence of sinking confidence in the national money is shown by the Indian government's increasingly radical and authoritarian attempts to prevent private citizens from buying gold.

Only theoretically because the time needed for a currency-triggered change of economic fortune can be long – on the positive side – but short on the downside, the argument for deliberately weakening the national money by operating “currency wars” is tempting. Capital inflows push up the exchange rate, making imports cheaper and exports dearer. The trade deficit balloons, growth slows, and deep-seated structural flaws in the economy leap into prominence - and the hot money flees. Keeping the money weak, despite the inflation danger, is therefore a supposed “no brainer” better choice. In the US, Bernanke is regularly, almost ritually accused of doing just that.

Already today, India's deepening money-and-economic crisis is called a deja vu revisit of the Asian crisis of 1997-98 that was an unheeded warning sign of what was in store for the global economy from 2008. The region's then-NICs or Newly Industrializing Countries were exhibiting record economic growth.  Inward investment surged, along with hot money flows to cherrypick local stock exchange flyers, and the region's shadow banking system went into high gear. Capital controls existed - only in theory. Local exchange rates soared against world moneys led by the dollar, the price of imports went down, exports were dearer. When the 1997-98 crisis hit, rolling devaluation in double digit percentage rates exceeding 40% was the the norm, investment plummetted, bankruptcies and unemployment soared. The region took at least 5 years to get over the crisis – but the crisis was local or indigenous.

Since 2008 we have a world crisis-prone financial and monetary system. A localized or “regionally contained crisis” like the Asian one of 15 years ago is no longer possible.

The trigger for the run on India's rupee has been the news and talk that the US Federal Reserve is considering scaling back - "tapering" - its bond-buying stimulus programme from as early as next month. This has consequences for all Emerging economies, firstly that reduced “fiscal stimulus” will mean weaker growth in the US, trimming imports from today's NICs including the two Asian giants, China and India - as well as Russia, Brazil, Indonesia, South Africa and Turkey. The upward trend in US interest rates is a death cross for previously high-yielding currencies like the rupee. When the dollar gets more attractive, the rupee is a loser.

While the Brazilian real, Indonesian rupiah, Turkish lira and South African rand are only beginning to feel the heat, it is India – with its large trade, capital and budget deficits – that looks like the first accident waiting to happen. Unfortunately, exactly as in 1997-98 and again in 2008, firstly in Asia's then-NICs, and then in developed countries policymakers did nothing in the hope that the problem would go away. The next entirely predictable phase of the crisis were hastily cobbled panic measures.

In the case of India we are already at stage two, featuring a range of announced, and probable capital controls and very likely central bank selling of dollars in an attempt to underpin the rupee. Stage three, as we know from the Asian crisis as well as Europe's post-2008 PIIGS crisis features calling in the IMF, along with the ECB and Germany in the PIIGS case. India is now on the cusp of stage three.

A CRISIS TOO FAR  FOR THE IMF
Asking the IMF how it rates its own handling of the Asian crisis 15 years ago is still a loaded question for this organization. For a decade after the Asian financial crisis the Fund experienced a slow-burning institutional crisis driven by a decline in the organisation’s practical legitimacy, controversy over the
distribution of voting power on its Executive Board, and widespread criticism of the stringent policy conditions attached to IMF loans. For international financial scholar Andre Broome writing in the February 2010 issue of the Australian Journal of International Affairs, the Asian crisis was a gamechanger for the IMF.

After the crisis, major sponsors starting with the United States sidelined the IMF in the construction of new global financial rules, choosing instead to work through other international forums, notably the G8 and G20 and the Financial Stability Forum. The IMF's handling of the Asian crisis – in the same heavy handed way as it handled in the 1980s Latin American and African Third World debt crises -  prompted the Emerging economies to take strenuous measures to not compromise their economic sovereignty through submitting to IMF loan programs. 

Put another way, it is almost sure and certain that India would reject IMF conditions – even IMF advice – on resolving its present monetary-and-economic crisis. India would demand “hands off aid”, or reject any aid at all.

As Broome says in his article looking at the Fund's world role since 2008, the organisation’s relative importance in the world economy tends to increase during episodes of international economic crisis
and to decrease during periods of macroeconomic stability. Therefore, since late 2008 the IMF has once again emerged as “the lender of last resort” and a crucial source of external financial support for Europe's PIIGS, and emerging market and less developed countries facing financial distress.

The G-20 heads of government meeting in London in April 2009 agreed - in principle - to triple the IMF’s lending capacity from $250 billion to $750 billion. Impressive on paper, this seems to imply the Fund is “back in business”, but its track record in the 1980s, and in the Asian crisis of 1997-98, and again in Europe's PIIGS after 2008 in tandem with the ECB has generated a backlog of distrust and disinterest in the IMF among potential borrowers. With a now very complex (called “flexible”) set of loan conditions and for scheduling repayments, it is also questionable as to whether the IMF could act fast enough if confronted by an Indian-scale crisis, where through sheer panic India was finally forced to go to the Fund for aid.

CONVERGENT CRISIS
The Asian crisis of 15 years partly converged with the Russian monetary and financial crisis of 1998, but the net result was contained, as the then-NICs of Asia started recovering quite fast, but Russia plunged into crisis. The crises were not exactly convergent and the knock impact of the Asian crisis on Russia was small or very small.

Today's potential “BRICs crisis” is highly convergent, even self-converging in major part due to what the 'Economist' calls the “unprecedented” growth of the Emerging economies – and as this IMF-source  chart shows, below, the “unprecedented” slowdown in Energy economy growth rates since 2010.

Today, the four BRIC economies are four of the world's ten largest economies, placing them at an entirely different rank of global damage potential, relative to the Asian NICs of the 1990s. The striking slowdown in BRIC growth rates is shown by a few figures. In 2007 China’s economy expanded by an eye-popping 14.2%. India managed 10.1% growth, Russia 8.5%, and Brazil 6.1%.

In 2013, using often disputed and controversial data form different sources including the IMF, China will probably grow by 7.5%, India by 5%, Russia by less than 2% and Brazil by 1.75%. India's rupee crisis signals that the above-cited forecast, for India, is already too optimistic. Present outlooks for Brazil place its likely 2013 GDP growth rate in real terms at about 1.6%.

The main argument used by “benign outlook” specialists like England's 'Economist', is that firstly another Asian crisis is not possible, but that secondly, if it was possible, it could be fuddled and muddled through for example by using the IMF's now-greater theoretical financial resources. This “benign outlook” theory finally reposes on the fact the world economy is much larger than it was 15 years ago -  twice as big in real terms as it was in 1992, using IMF figures.

The main problem is that emerging markets— whether the BRIC economies or what Goldman Sachs calls the N11 countries such as Bangladesh and Turkey “following on” from the BRICs — must deliver larger absolute increases in output every year to generate the same marginal economic boost to the global economy as they did during the 1990s and in 2000-2008. This is not possible. Put another way, the BRICs have to keep growing at “belle epoque” rates – or the global economy slows down rapidly.

The second “hypothesis” is a simple fact – not a theory – but the role of Emerging economy slowdown in accelerating global economic slowdown is under-appreciated. At least as important, IMF policy musing and theorizing about global monetary stability, which is in permanent high gear since 2008,  does not include the scenario of a BRICs country suffering a currency meltdown. As India's rupee crisis unravels we must hope that IMF experts in their Washington K-Street Ivory Towers are waking up to what this means.

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

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