Monday, May 10, 2010

Weekly Hurriyet Column: Hot money blows emerging markets balloon

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. As for cheesy references, I couldn't get any this time around:(

Everyone has got her own take on what caused last week’s wild ride.

For some, it was fears of euro area sovereign risk contagion. For others, it was China’s tighter monetary policy. Yet others tied the sharp falls to intraday selling by electronic trading systems.

I am more interested in consequences, but at first glance, this seems like an almost trivial exercise. In periods of contagion, investors become risk-averse and flock to safe-haven assets such as gold and U.S. Treasuries.

With the yield on 10-year bonds hitting below 3.3 percent, the lowest level since late last year, and gold surging above $1,200 an ounce amid Thursday’s turmoil, last week proved to be no exception. Then, it was no surprise that emerging market currencies suffered, but it was the different levels of misery that was most intriguing.

If you really try, you could tie the pressures on the Hungarian forint, the Polish zloty and the Czech koruna to fundamentals: In all three countries, policy-makers had recently voiced worries on the over-appreciation of their currencies and were willing to keep rates lower for longer- considerably more dovish, in other words, than the Central Bank of Turkey. There is also political uncertainty in the Czech Republic and Poland, with elections looming, and policy uncertainty in Hungary, as the new government intends to loosen fiscal policy.

But none of these changes the fact that Poland’s economy is essentially healthy. Neither can fundamentals explain the fact that these three currencies underperformed even relative to the beleaguered euro. Things get even trickier once you adopt a more global perspective. Other underperformers of last week were the Mexican peso, the Brazilian real, the Indonesian rupiah and the Korean won. Don’t waste your time trying to find similarities between these economies; I already did, to no avail - or at least until I looked into portfolio flows and discovered an almost perfect negative correlation with currency depreciation.

Countries that have received the most portfolio inflows in the last year seem to have experienced the largest selloffs last week. Poland, having received over $25 billion over the past year, is a case-in-point. Turkey, with less than $5 billion of inflows, is the other side of the coin. In the latter’s case, foreigners had actually significantly reduced their positions during the political crisis of 2008 and the Lehman collapse, but then never really got back in. With foreign presence so light, it was no surprise that lira tremors were less than peers.

This is not to say that fundamentals did not work in Turkey’s favor: The Central Bank’s relatively more hawkish stance compared to its peers, the large foreign currency resident deposits, the positive recovery outlook, and the country’s less ugly stature in the investors’ beauty contest I discussed a couple of weeks ago all helped to keep the lira relatively stable. But I would argue that they were merely talented supporting actors in a drama crowned by hot money.

Before you congratulate me for having written something useful for a change and go long-lira, note that other fundamentals such as external financing or the fair value of the lira do not justify more real appreciation no matter how hard you try. In other words, Economics is definitely not as lira-supportive as most analysts are fervently arguing.

But irrespective of your feelings for the lira, last week has provided, if anything, lots of lessons for students of finance as well as tremendous buying opportunities in the international currency arena.

Just remember that as John Maynard Keynes noted, markets can remain irrational a lot longer than you and I can remain solvent.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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