Some Thoughts On EM FX Intervention And Vulnerability
By Win Thin
Turkey central bank sold $750 mln and bought lira in its daily auction today. It offered as much as $1.35 bln and received $1.83 bln in bids. Yesterday, the bank offered and sold $140 mln and received $375 mln in bids. Monday, it offered and sold $50 mln and received $140 mln in bids, so the intensification of FX activity is quite clear. The central bank said that large dollar auctions may continue. The intensified intervention this week came as USD/TRY made new highs for this cycle above 1.90. In the current environment, however, the most that the Turkish central bank should do is to provide two-way liquidity in the FX market and not to defend any particular level.
We remain skeptical about this current bounce in sentiment and risk appetite, and so continue to believe that EM remains vulnerable to further bouts of selling. In this environment, we think EM currencies with weak fundamentals will continue to underperform. With EM reserve data being released now for September, we remind our readers that the drops reflect both FX intervention activity and valuation effects. That is, with the dollar significantly stronger across the board last month, reserves held in euros and other currencies were worth less in dollar terms. For instance, foreign reserves held in AUD would have seen a 10% valuation loss in September.
Turkey’s foreign reserves stood at only $85.65 at the end of September, which we see as very limited firepower. Reserves have fallen about $7.4 bln (-8%) from the July peak. According to the latest BIS triennial survey, average daily turnover in TRY was $14 bln in 2010. Burning through almost $1 bln per day is simply not a sustainable strategy. In a bit of a backdoor move, the central bank seemed to acknowledge this shortfall by doubling the amount of reserves that commercial banks are allowed to keep in foreign currency. It said that this move could boost central bank reserves by as much as $3.6 bln.
We note that Turkey has moved into very worrisome territory. According the central bank, short-term external debt rose to $84.96 bln, or basically 100% of foreign reserves this year. This is a very important ratio, and shows how vulnerable a country is to short-term swings in sentiment that can lead to capital outflows and FX volatility. Most in Asia and Latin America have much lower ratios, as Korea and Indonesia are both around 45%, Malaysia, Taiwan, and Thailand are all around 20%, and Brazil is at 20%. EMEA countries typically do not have big war-chests of reserves, and so their ratios are typically very high. Besides Turkey at 100%, Hungary is almost 120%, Bulgaria is around 105%, and both Czech and Poland are around 75%. South Africa is relatively low at around 50%.
Markets have been punishing countries with the weakest fundamentals, focusing on either high inflation, large current account and budget deficits, external debt loads, or a combination of these. These other vulnerability measures in the table also support the widely held view that Asia has the strongest fundamentals, EMEA the weakest, and Latin America somewhere in between. But we do note that there are pockets of vulnerability in Asia (India, Sri Lanka, Vietnam) and Latin America (Argentina).
Source: Bloomberg, IMF, BBH
In related news, it appears that the Russian central bank intervened directly in the FX market yesterday to the tune of $1.15 bln, according to Chairman Ignatiev. During the last protracted RUB selloff in 2008-2009, Russia burned through its reserves quite significantly, falling from a $596 bln peak in July 2008 to a trough of $384 bln in March 2009, a drop of $212.7 bln or -36%. Reserves were rebuilt to a peak of $545 bln in August, and dropped $19 bln to $526 bln as of September 23. Private capital outflows continue, reported at -$18.7 bln in Q3 and are expected to continue in Q4. However, we note that short-term debt to reserves for Russia is a low 23%.