Top Stories: Hot Times in Submerging Markets
By Peter Eavis and Erin Arvedlund
Staff Reporters
9/8/98 7:06 PM ET
Submerging markets are headed deeper and could still drag U.S. stocks into the vortex.
Brazil and Hong Kong, despite announcing measures in the past couple of days to protect their currencies, may still see the destruction of their dollar-pegged exchange rates by the end of the year. And Russia remains dangerously rudderless as it enters what may be a harsh and hyperinflationary winter.
Brazil Acts to Stay in the Game
Brazil's back is against the wall. The markets seem to be anticipating a crisis that could force a devaluation of the real by the end of the year, or even before the Oct. 4 elections.
Some $18 billion has fled the country since the beginning of August. This capital flight is getting worse by the day: Some $3 billion left the country on Friday, taking reserves down to around $56 billion. Brazil's equity market has halved in value in under six months. Its dollar bonds traded at 4.2% over U.S. Treasuries early last month and now have a yield spread of 11%, which is the market's way of saying that it now believes Brazil is twice as risky as it was just 30 days ago.
The government, after seeing nearly a quarter of its reserves disappear in a flash, finally responded on Friday by effectively hiking rates nearly 11 percentage points to 29.75%. On Tuesday, it announced that it was going to cut spending by $3.4 billion in the remainder of this year and continue big cuts through 2001 in a bid to trim the country's out-of-control fiscal deficit, which is equivalent to 7% of GDP. This shortfall is the main source of concern for investors.
The new measures may be a case of too little too late from a government that has made one gamble too many. The equity market's reaction was tellingly muted, with the Bovespa index actually down slightly today. Dollar bonds rallied, but remain close to bombed-out levels.
The market was unimpressed partly because it no longer trusts the government of President Fernando Henrique Cardoso, who polls suggest will be re-elected in October. Investors remember all too well that his government failed to implement nearly half of the proposed $18 billion of budget cuts it announced in the middle of the last big emerging markets sell-off.
Carlos Kawall, economist at Citibank in Sao Paulo, says that these cuts will be easier to implement because this time Cardoso has used a presidential dictate that will ensure they get done. If necessary he can see the cuts through even without the approval of Brazil's notoriously intransigent Congress.
However, Kawall pointed out that Friday's rate hike could neutralize a fair proportion of the budget cuts, as just under half of the government's domestic debt is tied to floating rates. He estimates that the rate hikes will cost an extra $1.28 billion per month.
If the outflows continue, then Brazil has two other possible drastic options left before devaluation: import controls and restrictions on capital outflows. But Kawall believes these would backfire and speed up outflows.
In better times, Brazil may be able to hold. But a lot has changed since last October. First, there's been a big sovereign debt default (by Russia on its ruble bonds) to spook investors. Second, investors have no hope at all that the IMF will provide Brazil with extra cash to defend its currency, as the multilateral organization now has insufficient reserves. Third, the U.S. market is much shakier than it's been for four years.
Hong Kong Peg Doomed
The measures announced Monday by the Hong Kong Monetary Authority almost certainly spell destruction for the ex-colony's dollar-pegged exchange rate, according to Independent Strategy, the London-based economics think tank that predicted the Asia crisis.
In a research note released today, Independent Strategy says that the new policies effectively amount to an attempt to replace Hong Kong's currency board with a central bank. When the market realizes that this is the intent, it will punish the Hong Kong dollar.
IS says that the government can now lend Hong Kong dollars against its entire currency reserves and therefore create much more money than it could before. In addition, it has set up a discount rate which it, and not the market, will essentially fix. "Our guess is that the HKMA will flood the market with liquidity to achieve low interest rates," the note says.
If it does that, then the peg's days are numbered. "It is going to try and target (low) interest rates by injecting liquidity at the same time as maintaining a fixed exchange rate," the note says. "Many central banks, including Thailand, tried that and failed. So will the HKMA."
Rudderless Russia
Absent a government, Russia faces the prospect of inflation of between 15% and 25% a month, and perhaps hyperinflation, by the end of this year.
And while some believe the Group of Seven may come to the rescue by funding a ruble currency board, current G-7 members are already publicly doubting Russia's ability to implement such an arrangement, as it requires tight fiscal policies and a relatively sound banking system.
Some economists expect the ruble to hit 50 to the dollar by the end of the year. It currently trades in the low 20s.
Some pundits believe hyperinflation is avoidable. J.P. Morgan economist Ralph Suppel, writing last Friday, suggests that inflation in Russia will surge to 100% by year-end, but that headline hyperinflation of past years -- 1,400% in 1992 and 900% in 1993 -- isn't in the cards.
"The Russian administration has gained experience from the disastrous consequences of hyperinflation in the early 1990s," he writes. Printing money would prolong the current crisis until parliamentary elections in 1999 and presidential elections in 2000, "raising the chances of a communist opposition return to power."
But no one can deny that Russia needs a government. The fact that President Boris Yeltsin didn't immediately renominate acting Prime Minister Viktor Chernomyrdin is a sign there's some horsetrading with the Duma going on for a compromise candidate. While a prime minister with Duma support may add some stability, there's no telling what economic platform such a person may support.
Secondly, Russia needs to avoid default looming on its dollar-denominated Eurobond debt and its Soviet-era Paris Club and London Club debt.
Russia has some breathing space before payments are due on these obligations. But here's the bad news: Russia is already technically in default on its dollar debt after failing to repay a loan to the U.S. government's Department of Agriculture.
The emerging markets hot spots are definitely getting hotter.
See Also
COMMENTARY FEATURES
Greed and Fear: Cacophony of Contagion
8/30/98 0 AM
Opinion: Emerging Markets Are Sinking Themselves
8/23/98 0 AM
LATIN LOOT
Brazil Weighs Currency Controls
9/4/98 4 PM
TOP STORIES ARCHIVE
|
