Zero Beta

It seems that across the emerging markets - particularly in Asia - we may be seeing a more modern strain of the Asian Flu that ripped across foreign exchange markets in 1997 - eventually leading to Russian Debt Default and LTCM.

It appears that this time, many countries are on the other side of the table - seeking to strengthen their currency instead of weakening - and facing inflation and “overheating” issues, while others (possibly the US) are in their shoes, forced to “defend” their currency.

From Thahn Nien Daily,

Some worry Asia’s second-biggest economy faces both risks.

China’s situation suggests Asia is on the cusp of its worst couple of years since 1997.

From Seoul to Jakarta and from Beijing to New Delhi, officials are grappling with a rapidly worsening inflation picture.

It would be nice if there was less concern about the phenomenon and more action to address it.

Asia may be nearing the point of no return - one where the region’s so-called economic miracle goes off the rails anew.

Asia isn’t about to revisit the darkest days of 1997 and 1998.

It was then that speculators tested central banks’ resolve to defend currencies.

Thailand’s devaluation in July 1997 set in motion a crisis that suspended the Asian miracle.

It prompted investors to leave Asia and sent contagion around the globe.

A decade later, Asia faces the flipside of that experience.

The turmoil of the 1990s was about deflation and recession; the situation today involves overheating.

Central banks may already be remiss in a different way than they were during the last crisis: They are falling behind the inflation curve.

“Inflation really has become the issue,” says Richard Grainger, a director at Barclays Capital in Hong Kong.

Surging inflation is adding pressure on officials to raise interest rates as record oil and food prices undermine growth.

That has created what central-bank heads such as Amando Tetangco of the Philippines call a “monetary-policy dilemma.”This is, admittedly, a touchy time for central banks.

They are being asked to tame forces they can’t fully control as “bond vigilantes” take matters into their own hands and boost bond yields.

Bottom line: Interest rates need to go higher in many economies.

Let’s go around the world to see some specific cases.

1.  Vietnam

Vietnam appears to be the biggest near term crisis at the moment.

A few highlights from Citywire,

F&C’s director of Asian equities, Jorry Noeddekaer, believes investors should be extremely wary of hotly-tipped Vietnam. He expects the stockmarket to keep falling and thinks a currency crisis to match Thailand’s in 1997 is possible.In January HSBC’s global head of emerging markets, Christian Deseglise, tipped Vietnam as one of the new emerging market frontier countries which investors should not overlook. Fidelity’s Teera Chapongsang also recently spoke of his bullishness about the country.

But inflation in Vietnam recently hit the 25% mark, and Noeddekaer is extremely wary of the country. He thinks Vietnamese ‘insiders shorting the currency’ could cause a major crisis.

Noeddekaer, who joined F&C from rivals New Star in 2006, compares Vietnam’s current situation to that of Thailand in 1997, when speculation on the Thai Baht helped to spark the Asia Crisis and crippled Thailand’s then-booming economy.

Some of the headline macro economic figures are looking worse in Vietnam now than they did in Thailand a decade ago. Inflation in Vietnam recently exceeded 25%, for example, whereas at the time of the Thai crisis inflation was just 4.5%. Meanwhile Vietnam currently has a current account deficit of 27% compared to a 6% level in Thailand prior to its crisis.

In Vietnam now you also have 25% of deposits being held in foreign currency, this is equal to 75% of its FX reserves,’ Noeddekaer says. ‘So a domestic flight to the US dollar could trigger currency crises.”So even though external debt of 30% of GDP is below the level Thailand had, Thailand had 72% external debt to GDP, there could still be a significant currency crisis from this development.’

Thailand in 1996 had a loan to GDP rate of 105% while Vietnam’s rate has now climbed to 96%. At that stage in Thailand, non-performing loans made up 50% of the figure, while Noeddekaer says a leading Vietnamese bank claims ‘non performing loans are 0.1% and will stay stable going forward.’ He finds this figure hard to believe.

‘I think we will see a real devaluation of the currency, I could potentially see a drop of something like 25%. There is also a very high risk of a banking crisis.’

2. Sri Lanka

From Bloomberg,

May 30 (Bloomberg) — Sri Lanka’s inflation accelerated for a fifth month in May, indicating government efforts so far have failed to cool prices rising at the fastest pace in at least four years.

Consumer prices in the capital Colombo rose 26.2 percent from a year earlier, after increasing 25 percent in April, the statistics department said today. The median estimate of nine analysts in a Bloomberg survey was for a gain of 26.5 percent.

Sri Lanka’s 2008 inflation rate is likely to be “significantly higher” than previous estimates as oil reaches records, the central bank said on May 26. Governor Nivard Cabraal has kept borrowing costs at a six-year high to damp consumer spending and loan growth.

“A large part of the rise in inflation can be explained by surging international food and oil prices,” said Prakriti Sofat, an economist at HSBC Holdings Plc in Singapore. “Strong demand at home, the result of past policy looseness, is allowing retailers to pass on that cost to consumers.”

Central Bank of Sri Lanka said last month it was revising down its 2008 quarterly targets for reserve money, or the currency in circulation and commercial banks’ deposits at the central bank, which would help slow consumer-price gains by “containing the demand-driven component of inflation.”

“The central bank has been restricting reserve money growth in a meaningful manner since September last year, which should help cool domestic demand and temper inflation over time,” said Sofat. “The benefits may be limited in the near term on account of rapidly rising commodity prices.”

3.  South Korea

The Won is down almost 10% this year and is having a hard time fighting inflationary pressures.

From Bloomberg,

June 9 (Bloomberg) — South Korea needs to seek `stability’ in its currency and interest rates after consumer prices soared last month, Finance Minister Kang Man Soo said.

“Consumer prices have risen quite a lot,” Kang said on SBS radio from Seoul today. “Interest rate and currency should be operated taking into consideration the new environment. Stability should be sought because of (rising) prices.”

Rising commodity prices, together with a weaker won, have damped domestic demand by raising living costs for households and eroding corporate profit margins. Inflation accelerated to a seven-year high of 4.9 percent in May, and the economy’s growth rate in the first quarter was the weakest in more than a year.

The Bank of Korea has left the nation’s benchmark interest rate unchanged at a seven-year high of 5 percent since August, saying inflation remains a threat. The bank’s policy board next meets on June 12 to decide on rates.

4.  Pakistan

Pakistan is one to watch for all the political aspects of the situation, but they appear to be in credit trouble.

From Bloomberg,

June 10 (Bloomberg) — Pakistan’s first civilian government since a 1999 army coup may expand food and power subsidies as the fastest inflation in at least 25 years erodes growth.

Increased government spending on populist measures may blow out the budget deficit to as much as 7.5 percent of gross domestic product, the widest in Asia, said Zainab Jabbar, an analyst at IGI Securities in Karachi. Finance minister Naveed Qamar, appointed less than five weeks ago, is due to present the 2008-09 budget in Islamabad on June 11.

“All indications are that political considerations will dominate fiscal policy,” Jabbar said. “Confusion over dates and retractions of announcements are redolent of instability within the political and fiscal framework.”

Pakistan’s coalition government has changed the date for its budget two times in the past six days, giving no reasons for the delays. Confusion over who is managing the $146 billion economy may deter much-needed foreign investment, which has already fallen this fiscal year for the first time since at least 2004.

Moody’s Investors Service on May 21 cut Pakistan’s credit rating for the first time in nine years, citing “growing economic imbalances and renewed political difficulties.” Standard & Poor’s also reduced its rating on May 15, making it more costly for Pakistan to finance its budget gap.

Pakistan’s two-month-old government is in disarray after former premier Nawaz Sharif’s Pakistan Muslim League and the party’s nine ministers quit the cabinet in a dispute over the reinstatement of judges sacked by President Pervez Musharraf last year. Sharif agreed to share power with the Pakistan Peoples Party of assassinated opposition leader Benazir Bhutto after parliamentary elections in February.

The benchmark stock index, which gained as much 14-fold since 2001, tumbled 20 percent in May on reports that Musharraf will be forced to resign by the ruling alliance and on concern an unexpected move by the central bank to increase interest rates will damp consumer spending and investment.

Overseas investors have also been worried about political instability in South Asia’s second-biggest economy. Foreign share investors bought $119.4 million of Pakistani stocks in the first 10 months of the fiscal year that started July 1, compared with purchases of $1.76 billion a year earlier.

Pakistan needs more foreign investment to boost economic growth, which the government expects to weaken this year to as low as 5.5 percent after averaging 7.5 percent in the past four years. A faster pace of expansion may help the government of new Prime Minister Yousuf Raza Gilani reduce poverty in a nation where two-thirds of the population of 160 million people survive on less than $2 a day.

5. The Philippines

The Philippines situation seems interesting and should be watched as the peso is plummetting and it appears that the Central Bank is takign a very “hands-on” approach as food riots and protests heat up.

From the Philippines Daily Inquirer,

Recent swings in the peso-dollar exchange on currency spot market have prompted the central bank, Bangko Sentral ng Pilipinas (BSP), to take a closer look into banks’ currency deals with overseas investors.

The BSP recently required banks to report their non-deliverable forward (NDF) transactions with offshore investors on a weekly basis, including the agreed exchange rate, volume and the maturity of transactions.

According to the Organization for Economic Cooperation and Development (OECD), an NDF contract is a foreign-currency financial derivative instrument. An NDF differs from a normal foreign-currency forward contract in that there is no physical settlement of two currencies at maturity. Rather, based on the movement of two currencies, a net cash settlement will be made by one party to the other, OECD explained.

As the new measure coincided with the peso’s weakening trend against the US dollar, there have been speculations in the market that this could be a prelude to the central bank’s eventual move to cap NDF deals by instructing banks to include such transactions in the computation of allowable foreign exchange stock or overbought limit.

In an e-mail last Friday, BSP Governor Amando Tetangco Jr. said NDF transactions could indicate “the level of risk appetite of investors for emerging markets such as the Philippines.”

“These transactions could cause volatility in the spot onshore market,” Tetangco explained. “For these reasons, BSP needs to monitor these flows closely. Hence, the clarification of our reportorial requirements in our latest issuance.”

Tetangco did not comment on whether the NDFs could soon be included in the overbought limit.

The peso closed Friday at 44.135 to the dollar. (Monday was a non-working holiday.) Since the start of the year, it has lost 6.6 percent. Last year, it rose by nearly 19 percent against the dollar.

Some banks estimate the outstanding peso-dollar NDFs between banks and offshore parties at $6 billion. Others say some banks would exceed the overbought limit of 20 percent of unimpaired assets if these NDFs were included in the computations.

Currency forwards refer to agreements to buy or sell specified amount of goods to be settled at a specified rate in the future.

In the case of NDFs, which played a big role in the sharp currency swings during the Asian financial crisis, only the exchange rate differential is settled upon maturity.

6. Thailand

Yes, Patient Zero from the last epidemic is back, appears to be debating taking a second crack at supporting the baht.

From UPI.com,

BANGKOK, June 6 (UPI) — The Bank of Thailand suggested it would not takes steps to prop up the falling value of the baht, because it did not want to interfere with the market process.

“We have not intervened in the baht value for a while,” the bank’s governor, Tarisa Watanagase, said in a report from the Thai News Agency. “Today, we cannot tell whether we will intervene to supervise the currency movement or not.”

The baht is falling, but at a pace consistent with other regional currencies, the agency reported.

“We have our own ways to oversee the currency, but cannot tell in detail,” Tarisa said.

On Friday, the baht was valued at 33.16 to a dollar.

7.  India

Yes, even BRIC’s are susceptible.  It appears that India is suffering from both slowdown and inflation.   Perhaps they are rethinking that curb on foreign funds they put in in October.

From Gulf News,

Mumbai: India’s widening current-account deficit and slowing capital inflows from overseas have denied policymakers the option of letting the rupee gain to curb inflation, according to Fitch Ratings.

The local currency this year has pared more than half of its advance in 2007, when it rallied 12.3 per cent, the most in more than three decades.

Sales of local stocks by overseas funds and rising oil prices sparked the slump. India’s annual inflation rate more than doubled to 8.24 per cent in the week ended May 24 from a five-year low of 3.07 per cent mid-October.

“Our sense is that when the inflation numbers had started to go up, the central bank had the option to allow the currency rise at their discretion,” James McCormack, Fitch’s head of Asia-Pacific sovereign ratings, said in Mumbai on June 6. “That has now been taken away because the current-account position isn’t strong and capital inflows aren’t rising either.”

India’s trade deficit widened to a record $9.9 billion in April while the shortfall in the current account, a broad measure of trade and investment flows, widened to $5.4 billion in the quarter through December from $4.7 billion in the previous quarter, according to the central bank.

“Exchange rate appreciation pressures persisted last year because of the flows,” McCormack said.

“They don’t have the option now. Over time there will now be pressure on the exchange rate to weaken. The rupee is going to remain on the same course for the rest of the year.”

Overseas money managers sold $4.8 billion more local shares than they bought this year, more than a fourth of their record net purchases in 2007, according to data provided by the Securities and Exchange Board of India.

8.  Venezuela

Hugo Chavez is starting to find out that cutting off the supply of dollars does not come without its costs.

From pr-inside.com,

CARACAS, Venezuela (AP) - Consumer prices in Venezuela rose 3.2 percent in May _ the country’s highest monthly inflation rate this year.
Prices increased by 12.4 percent during the first five months of 2008, according to Central Bank figures released Monday.
If inflation continues at this rate, it will close the year at about 30 percent _ even as first-quarter growth slowed to 4.8 percent, a four-year low.
President Hugo Chavez’s socialist government has tried price and currency controls and raised some interest rates to try to hold down inflation, which is running at the highest pace in Latin America.
Annual inflation in metropolitan Caracas reached 29.3 percent in April, the latest figure available. The Central Bank adopted a new method of measuring national inflation this year _ incorporating smaller cities and making nationwide year-to-year calculations difficult.
Venezuela’s May inflation rate is more than triple those of neighboring countries like Colombia and Brazil, which reported rates last month of less than 1 percent.
Caracas authorized price hikes on price-controlled items including chicken and corn flour last month to combat shortages. The Central Bank said that partly explains why inflation rose from 1.7 percent in April.
Inflation was also affected by high prices in the food and service sectors _ including restaurants, transport and health care.
Economist Asdrubal Oliveros, director of the private firm Ecoanalitica, said a 30 percent wage hike in May for those earning minimum wage or working in the public sector has also had an impact on soaring prices.
Oliveros said he is «very worried» about May’s inflation level, which comes as the government is planning to make economic adjustments.
Chavez soon plans to announce a package of economic measures to boost growth, Information Minister Andres Izarra said last week. The president will also appoint a new finance minister to replace Rafael Isea, who is stepping down to run for a state governor’s post.

9.  Argentina

An alumni from the momentary “relapse” in 2003, is finding that price controls to try to cut inflation off at the source can backfire.

From the AP,

BUENOS AIRES, Argentina (AP) — Argentina, one of the world’s biggest breadbaskets, should be rolling in cash as world food prices soar.

Instead, soy, wheat and corn have sat for weeks in silos as farmers protesting new export taxes suspended sales.

Farmers were lifting their strike Sunday night in a last-ditch effort at a third round of talks. But their three-month standoff with the government has already paralyzed the rural economy, caused scattered food shortages and tanked the new president’s popularity.

And continued stalemate could spike global grain prices at a time when food costs are already high.

Still, experts say grain prices won’t rise forever, and many warn that Argentina may be missing its shot at that record revenue — and headed for economic crisis.

“They are killing the goose that lays the golden eggs,” said Claudio Loser, a former Latin America director at the International Monetary Fund.

Farmers meet Monday with a national ombudsman who has offered to broker the crisis, but the government has not yet agreed to join talks.

Argentina is one of the world’s top four providers of soy, corn, beef and wheat, and rising farm exports — up 48.2 percent since 2003 — helped the country rebound from economic meltdown in 2002, driving five years of more than 8 percent annual growth.

Exports stood to climb even higher this year, as international soybean prices jumped about 26 percent and corn prices about 34 percent between January and June.

To tap those gains, President Cristina Fernandez decreed a new sliding-scale tax on March 11, boosting rates on grain exports as prices rise. Current export taxes on soy, for example, jumped to 46 percent from 35 percent, and would top 50 percent if prices swelled above $600 a metric ton.

The move was meant to tame inflation by trapping exports in Argentina, driving down local prices and encouraging cultivation of stocks like wheat and cattle, which have been abandoned for more lucrative soy.

But objecting farmers have suspended grain shipments for 89 days in protest, crippling rural towns with roadblocks and layoffs and causing food shortages in cities including Buenos Aires. Cattle ranchers affected by separate export restrictions also halted sales.

10.  The United States

Ah yes, send in the clowns.  While not an “emerging” market by any definition it should be noted that we were the first emerging market - ask Spain.  With the credit problems still alive, recession looming, oil rising, and the Fed essentially done easing, the dollar is at a major crossroads. Today, China called us out, as the Yuan continues to set new highs.  They said,

The continued depreciation of the dollar “aggravated the inflation pressure worldwide and further added fuel to the rapid increase of the crude oil and food prices,” said Sun at a WTO session reviewing the trade policies of the United States.

The depreciation also seriously affects the exports of other countries, especially those vulnerable and export-oriented developing countries, undermining their ability to further develop and to address their social problems, Sun said at the biennial review.

Ouch.  With a jab like that, how did the US respond?

From the Associated Press

WASHINGTON (AP) — President Bush’s forceful call on Monday for a stronger U.S. dollar in the world economy may be coming a little late for Americans fed up with gas prices topping $4 a gallon and steadily rising costs of other imported goods.

As he left for Europe, the president said the U.S. is committed to keeping its currency strong, a point he clearly felt needed to be made after the dollar’s long slide against the euro and other international currencies.

Bush’s words signaled his administration’s concerns about the economy. The sinking greenback is one reason that fuel prices are at record levels, and the run-up in energy prices is battering consumers and worsening the risk of recession.

“A strong dollar is in our nation’s interests. It is in the interests of the global economy,” Bush said outside the White House.

Bush and Treasury Secretary Henry Paulson appear to be easing away from their hands-off approach to managing the value of the dollar. While a strong dollar has long been stated U.S. policy, that usually has amounted to no more than rhetoric unbacked by specific steps.

The government has limited options for propping up the greenback, especially in an election year with rising unemployment, slumping consumer confidence and the worst housing market in decades.

Paulson declined to rule out direct intervention — the buying by the government of dollars in currency markets — as a way to influence the currency’s value. Another way to shore up the dollar is for the Federal Reserve to raise interest rates — seen as an unlikely prospect given the current state of the economy.

For seven years, the administration has refused to intervene in currency markets, even though the dollar has been sliding in value for most of the time Bush has been in office. The administration has insisted that currency levels should be set by free-market forces.

Bush, in an interview with the Times of London as he flew across the Atlantic, added to his earlier comments, saying, “We want the dollar to strengthen.”

Overall, it appears that instability is rising. Many of these economies are lucky enough to have inflation alongside actual growth, but what happens when that growth slows and funds move out as there is a good amount of retail money in these countries after five years of 30% returns.  Are we about to see the same bad movie again as another currency crisis sweeps through the Emerging Markets, or have we gone full cirlce from the Plaza Accord and Emerging economies, and perhaps even Japan, are set to have a 20 year inflationary binge.   Time will tell