Emerging Markets Raise Bond Rates

Emerging markets' central banks are raising short-term interest rates to defend plunging currencies and counter the effect of forthcoming QE tapering in the US

Dave Sekera, CFA 24 September, 2013 | 11:36AM
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Among Morningstar's fixed-income indexes, the emerging markets have been some of the worst-performing categories since the beginning of the year. Over the past few years, easy money policies for the developed world have sent substantial capital flows to the emerging markets in search of higher yields. However, as investors became increasingly convinced that the Federal Reserve was going to begin tapering its asset purchases this fall, those capital flows reversed. Losses have been driven by a combination of capital outflows as well as rising interest rates. To stem the capital outflow, many countries' central banks have been raising their short-term lending rates to defend their currencies. As their currencies begin to recover their losses, the indexes have begun to recapture some of their losses. 

At its lowest point toward the end of June, the Emerging Market Composite Index had declined 8.70%, but it is currently down only 4.81%. Among the constituent members of this index, year to date through Sept. 20, the Emerging Markets Sovereign Bond Index has suffered a 3.15% loss and the Emerging Markets Corporate Bond Index has declined 3.65%. Morningstar's Emerging Markets High Yield Bond Index has declined 4.5%.

At the end of August, Brazil's central bank raised its short-term lending rate by 50 basis points to 9%, its fourth hike since March. The real had lost as much as 20% of its value versus the dollar this year through mid-August, but it has since regained some of the deterioration and is currently only down about 10%. In a surprise move, the Bank of Indonesia has become increasingly aggressive in defending its currency and recently raised its benchmark interest rate by 25 basis points to 7.25%. This move came just two weeks after Indonesia's central bank had increased its rate by 50 basis points. The rupiah has fallen 14% this year. While Turkey kept its short-term rate steady at its September meeting, it had increased its overnight lending rate by 50 basis points to 7.75% at its August meeting. The lira has fallen 9.5% this year. In July, the Reserve Bank of India hiked its short-term rate by 200 basis points to 10.25% to defend the rupee. At the end of August, the rupee had fallen as much as 25% against the dollar this year, but has since recaptured some of its losses in September and is currently down 15% versus the dollar for the year.

As these countries raise their short-term interest rates in defense of their currencies, the risk is that they may raise rates to levels that begin to slow their economic growth. This could then have a domino effect on other emerging-market countries. If their economies slide into recession, then in addition to the regional impact, the contagion could spread to resource-rich nations, such as Australia and Canada, which derive a significant amount of their GDP from mining and minerals.

This article was originally published on Morningstar.com

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Dave Sekera, CFA  is a senior securities analyst with Morningstar.