Brazil, India, Indonesia, South Africa, Mexico and Turkey. These are the emerging countries whose currencies are currently involved into one of the most dramatic currency crises that the world remembers in recent times. This crisis is likely to become even more devastating than the big Asian financial crisis of 1997-98 and these countries could be the big casualties of the currency war sparked some months ago by the most influencing central banks. Central banks are currently engaged into a dramatic quantitative easing war, fought through the targeting of exchange rates and flooding financial markets with an ocean of liquidity. In particular, two of them have the potential to change, with their decisions, the future of financial markets: the FED and the People’s bank of China.

1. Currency wars
FIT Group Papers n.5
Observatory on Emerging Currencies

2. History repeats itself: from the 1997-98 to the actual currency crisis
Brazil, India, Indonesia, South Africa, Mexico and Turkey. These are the emerging countries
whose currencies are currently involved into one of the most dramatic currency crises that the
world remembers in recent times. This crisis is likely to become even more devastating than the
big Asian financial crisis of 1997-98 and these countries could be the big casualties of the
currency war sparked some months ago by the most influencing central banks.
Just to remember, the 1997-98 Asian currency crises was ignited, among other factors, by a
decision taken by the FED to raise US interest rates. As a consequence, investors withdrew their
money from risky emerging countries while looking for higher and safer returns on domestic
assets.
Normally, under an expansionary monetary policy, such as a Quantitative Easing, when a central
bank buys tons of government bonds in a bid to push up their prices and reduce interest rates
across the economy, financial institutions exploit the cheap cash to go abroad in search of more
promising returns. But when the central bank inverts the stance of its monetary policy, the same
institutions invert the sign of their investments too, leaving emerging countries in liquidity
leakages. This is exactly the risk that these countries are bearing after the announcement by the
FED to raise US interest rates.
Some macroeconomic data
The risk of a currency crisis is higher when a country has its macroeconomic fundamentals out of
order, especially in the presence of high inflation rates and big current account losses. From this
point of view, according to the most recent macroeconomic data by the IMF (see Table 1) we can
observe that inflation does not represent a big risk, since all the examined countries have
moderate inflation rates. Instead, the possible macroeconomic threat can be represented, for
South Africa and Turkey, by wide current account deficit (-5,6% and -5,9% of GDP in 2015,
respectively).
Quantitative easing, interest rates and currency wars
Central banks are currently engaged into a dramatic quantitative easing war, fought through the
targeting of exchange rates and flooding financial markets with an ocean of liquidity. In particular,
two of them have the potential to change, with their decisions, the future of financial markets: the
FED and the People’s bank of China.
The US Federal Reserve ended the third round of Quantitative Easing the last 29th
October 2014
and she is now very close to raise interest rates, almost certainly by the end of the year (maybe

3. twice), sparkling fears of a world currency crisis day after day. But members of the FOMC are
entrapped into an hamletic dilemma, about whether to raise or not to raise interest rates. On the
one hand, they would like to follow the classic rule of thumb (increase rates when the domestic
economy goes well in order to avoid inflation); on the other hand they know that this time is
different, since US interest rates have never been so low and the bank is sailing on unknown seas.
An increase of interest rates, in fact, would push the dollar high, with negative consequences on
US exports. The problem is exacerbated by the behavior of the other central banks. The ECB, for
example, is playing a dangerous game. Theoretically, the bank cannot fix any exchange rate target
since this goal is forbidden by the European treaties. Nevertheless, there is no doubt that the
launch of the quantitative easing aims also to help the local currency to depreciate against the
dollar. Also Bank of Japan has followed the Quantitative Easing strategy, in order to make an end
to its secular deflation problem. But, for sure, the most important intervention on financial
markets was made by the People’s bank of China, which launched a three-day devaluation of yuan
against the dollar, using, de facto, the same weapon used by her Western counterparties. How else
can this be defined but a currency war? Could this move change the FED decision to raise US
rates? Probably not, but the recent move by the PBOC throws a totally new strategic variable into
this, apparently cooperative, practically non-cooperative game.
A deep devaluation
As of August 14th
2015, the Brazilian real has lost -42.22% of its value against the dollar since
the end of the Quantitative Easing by the Federal Reserve (October 29th
2014) and -106.12%
since the announcement of the second round of Quantitative Easing (November 3rd
2010), when
the FED made clear that she intended to play the major role to solve the financial crisis. Over the
same time horizons, as Table 2 shows, the Indian rupee has lost -6.30% and -46.88%,
respectively, the Indonesian Rupiah -13.16% and -54.81%, the South African Rand -16.73%
and -86.16% and the Turkish lira -26.47% and -97.59%.

4. Table 1 – Macroeconomic data
2012 2013 2014 2015 2016 2017 2018 2019
Brazil Inflation rate % change 5.4 6.2 6.2 5.8 5.6 4.9 4.6 4.5
Current account balance % of GDP -2.4 -3.6 -3.5 -3.6 -3.6 -3.4 -3.5 -3.5
India Inflation rate % change 10.2 9.4 7.8 7.4 6.7 6.2 6.2 6.0
Current account balance % of GDP -4.7 -1.7 -2.0 -2.2 -2.3 -2.4 -2.5 -2.5
Indonesia Inflation rate % change 3.9 6.4 5.9 6.7 6.0 5.5 5.2 5.0
Current account balance % of GDP -2.7 -3.3 -3.2 -2.9 -2.7 -2.6 -2.6 -2.5
South Africa Inflation rate % change 5.6 5.7 6.3 5.8 5.5 5.3 5.3 5.3
Current account balance % of GDP -5.2 -5.8 -5.7 -5.6 -5.3 -5.1 -4.8 -4.6
Turkey Inflation rate % change 8.8 7.4 9.0 6.9 6.4 6.1 6.1 6.1
Current account balance % of GDP -6.1 -7.9 -5.8 -5.9 -5.9 -5.7 -5.7 -5.7
Source: IMF, World Economic Outlook, October 2014
Table 2 – USD vs. emerging currencies exchange rates (as of August 14th
2015)
14/08/2015(*) 29/10/2014 13/09/2012 3/11/2010 15/09/2008
USD exchange rates
FED announces
the end of QE3
FED announces
QE3
FED announces
QE2
Lehman Brothers
bankruptcy
Brazilian Real 3,5 2,461 2,027 1,698 1,811
Indian Rupee 65,03 61,175 55,215 44,275 45,662
Indonesian Rupiah 13821,94 12215 9571 8928,571 9433,961
South African Rand 12,78 10,948 8,325 6,865 8,064
Turkish Lira 2,79 2,206 1,806 1,412 1,261
Source: FreeCurrenciesRate.com
(*) last available data
since the end of QE3 since QE3 announcement since QE2 announcement
Brazilian Real 42,22% 72,67% 106,12%
Indian Rupee 6,30% 17,78% 46,88%
Indonesian Rupiah 13,16% 44,41% 54,81%
South African Rand 16,73% 53,51% 86,16%
Turkish Lira 26,47% 54,49% 97,59%

5. Currency Wars
FIT Group Papers n.5 – Observatory on Emerging Currencies
Director: Dr. Emanuele Canegrati
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