EM Countries Are Back Defending Their Currencies

Here we go again. Faced with a stronger dollar and weaker commodities, many EM countries are back defending their currencies.

• Earlier this month, Malaysia’s central bank began verbal intervention.
• In Russia, Putin has called for “harsh” measures against ruble speculators then back it up with nearly $2bln
• Mexico just announced it will once again start selling dollars in daily auction to defend the peso.
• In Brazil, the current back drop will likely help to clarify the question of what the central bank will do with its FX swaps program: it will probably not be unwound, and may even have to be increased.
• This brings us to China. So why is the PBoC guiding the CNY fixing stronger?

It started with the usual shot against speculators. Earlier this month, Malaysia’s central bank began verbal intervention. It told lenders to guard against speculation. It reminded markets that short-dated transactions must be backed by underlying documentation. There is also talk about modest intervention, but nothing substantial as far as we know.

In Russia, Putin called for “harsh” measures against ruble speculators. After that, the central bank backed it up with $1.9 bln in FX sales, the biggest intervention since late October. The central bank is likely to hike rates in the next meeting.

Mexico just announced it will once again start selling dollars in daily auction to defend the peso. Banxico suspended these dollar auctions back in April 2013, which had been in place since November 2011. Back then, the interventions were triggered by a 2% move from the previous day. Now, it’s set at 1.5% daily change. Amounts are less, however, $200 mln now vs. $400 mln before. The communication has not been the best. Just last week, Governor Carstens was suggesting a need for further peso weakness. Still, think the move should be seen at face value: to reduce the extreme volatility and provide liquidity. It does not reflect concerns about financial stability or even inflation pass-through, so far. While on one hand we think Banxico has plenty of credibility to achieve its goals, on the other hand we don’t think they will be as strong handed as other central banks may be. So in short, the move will help Mexico outperform currencies without intervention programs (say, ZAR), but not ones with more aggressive ones (say BRL and TRY).

In Brazil, the current back drop will likely help to clarify the question of what the central bank will do with its FX swaps program: it will probably not be unwound, and may even have to be increased. Brazil still has a serious inflation problem and has not yet established a credible fiscal anchor. A precipitous decline in the currency will just fuel the panic we are seeing in equity markets (already down over 8% just this month).

This brings us to China. Isn’t China supposed to be an example of a mercantilist economic model? And isn’t the country closer to a deflation threat (especially PPI) than inflation? Isn’t there an economic slowdown in China? So why is the PBoC guiding the CNY fixing stronger? Yes, CNY spot has been weakening, but the PBoC has been fixing lower (there is a 2% fluctuation band around the fixing.) See graph. There are several possible reasons, here are two: (1) China will use this moment to establish the CNY as a reliable and stable currency on the world stage – as a medium of trade, investment and reserve accumulation. (2) China wants to ensure foreign capital does not leave and, ideally, continues to flow in. This is part of a larger plan to deflate the shadow banking system by using more foreign investment as a partially substitute, as well as diverting money from the likes of trust funds to the official capital market (say, stocks and banks).

Courtesy of EM Bits

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