Guest post: Desperate Times, Desperate Measures

by Joseph P. Joyce (is a Professor of Economics at Wellesley College and the Faculty Director of the Madeleine Korbel Albright Institute for Global Affairs )

Desperate Times, Desperate Measures

The selloff of emerging market currencies and equities continued last week. A Bank of America report noted that investors withdrew $6.4 billion last week from emerging market stock funds, while bond investors are also showing signs of retreating. Moreover, the declines in currency values have expanded outside the “Fragile Five” of Brazil, India, Indonesia, South Africa and Turkey to include Argentina and Russia. What can policymakers do to offset the declines?

Kristin J. Forbes and Michael W. Klein have examined the policy options available to governments that face crises due to contracting capital flows and their impact on GDP growth, inflation and unemployment. The measures include a rise in interest rates, currency depreciation, the sale of foreign exchange reserves and new controls on capital outflows. They report that currency depreciations and reserve sales will provide support for GDP growth, while increases in interest rates and or imposing capital controls do not. But the beneficial impacts of the first two sets of policies appear with a lag and may generate higher inflation. None of the measures improve unemployment.

Christian Saborowski, Sarah Sanya, Hans Weisfeld and Juan Yepez of the IMF also looked at the effectiveness of capital outflow restrictions. They report that controls on outflows can be effective in reducing net outflows only when countries have good macroeconomic fundamentals, as measured by their records of GDP growth, inflation, fiscal policy and their current account balances, or good institutions. Iceland’s use of controls in 2008 is cited as a recent example of a successful use of controls. Of course, an economy with strong macroeconomic conditions is less likely to face substantial outflows.

We can use the indicators used in the IMF study to assess macroeconomic conditions in the countries in the headlines last week. The data are from 2013:

GDP Growth
Fiscal Budget/GDP
Current Acct/GDP






South Africa


All the countries had rising inflation rates, with India’s hitting double digits. The current account deficits were particularly high for South Africa and Turkey, while India and South Africa had fiscal deficits of about 5%.  Russia’s growth rate was the lowest in this group.

And then there is Argentina. No one believes the inflation rate that the government reports; unofficial estimates place it at around 28%. The government has sought to restrict capital flows while also pegging the exchange rate. But foreign exchange market intervention by the central bank has not stopped an unofficial market from springing up. Last week the central bank, which saw its foreign exchange reserves shrinking precipitously, stepped back and allowed the peso to fall by more than 15%. The government also enacted a partial liberalization of the controls on the purchase of foreign exchange. But there are no signs of a response to inflation, and President Cristina Fernandez de Kirchner, who faces a term limit, has little incentive to take measures that in the short-term could further anger Argentine citizens.

Turkey’s central bank also acknowledged the strength of the forces arrayed against it when it announced a sharp rise in interest rates.  But foreign investors are concerned about corruption and political instability, and the Turkish currency has continued to slump. The Prime Minister’s opposition to the higher interest rates was not reassuring.

When will the withdrawals of money from the emerging markets end, and how will all this play out? The governments of the affected countries are using combinations of all the measures that Forbes and Klein list. But the most diligent central bank can not neutralize the impact of a weak or conflicted government. The financial volatility will continue until some sort of resolution is found to the political volatility.