(Bloomberg) — Emerging-market central banks are becoming the first line of defense to shield local currencies pummeled by speculative attacks and fiscal shortfalls.
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The latest bout of intervention from Latin American central banks in the currency market shows their tug of war with hot money is likely to persist until governments rein in spending. Over in Asia, the People’s Bank of China is enlisting more tools to defend the yuan as disappointing fiscal stimulus so far in the face of anemic growth and US tariff threats weaken the currency.
“Central bank currency intervention is not a tool that can adequately or sustainably defend regional currencies,” said Brendan McKenna, an emerging-markets economist and foreign-exchange strategist at Wells Fargo Securities LLC in New York. Shifting back toward fiscal responsibility would be the most effective way to stabilize a currency, he added.
The dollar’s surge due to a resilient US economy and expectations of fewer interest-rate cuts from the Federal Reserve have put central banks around the world on guard to defend their currencies and avert capital outflows. However, emerging market governments are constrained from deploying more fiscal firepower to bolster growth due to their elevated debt levels following the Covid pandemic.
The PBOC is keeping a tight grip on the yuan with its daily reference rate, around which the yuan can trade in a 2% range versus the dollar. It’s also planning to sell bills in Hong Kong to tighten liquidity offshore and drive up demand for the currency. But that’s hardly taming bearish bets as the onshore yuan lingers near the weak end of its allowed trading range.
Bank Indonesia is planning to help the government refinance maturing pandemic-era debt. Brazil’s central bank led a historic intervention to defend the real which fell to a record low versus the dollar in December due to a ballooning budget deficit, while the Colombian monetary authority surprised markets by slowing its easing campaign due to uncertainty over government finances.
But these moves may only slow the inevitable impact on their currencies, as investors remain reluctant to buy on dips unless there’s a noticeable improvement in fundamentals, which would need to come mainly from the fiscal side.
PBOC Pushback
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As the economic anchor of emerging Asia, China’s battle with speculators is keenly watched.
In its latest move, the PBOC suspended government bond purchases to curb a decline in bond yields and the yuan. However, currency traders remain on tenterhooks as they wait for US President-elect Donald Trump’s policies following his inauguration on Jan. 20.
“We assume that Beijing will respond to any major tariff announcement from Trump’s team with a one-off devaluation of its currency,” said Homin Lee, senior macro strategist at Lombard Odier. This higher flexibility for the yuan post-devaluation will provide greater scope for monetary easing to support the economy, he added.
The PBOC earlier this month reiterated its pledge to lower interest rates and the reserve requirement ratio for banks “at an appropriate time.” China’s finance minister said on Friday the nation will adopt a proactive fiscal policy and speed up the implementation of pro-growth measures.
Strategists at Bank of America still forecast the yuan falling to 7.6 per dollar in the first half of the year.
Fiscal Dominance
The rising risk of fiscal dominance — where ballooning budget deficits are spurring inflation — are blunting the impact of monetary policy.
In Brazil, economists last month raised their 2025 inflation forecasts further above the top of the central bank’s tolerance range, and most analysts see the Banco Central do Brasil’s tightening cycle extending through mid-2025. However, mounting investor skepticism over President Luiz Inacio Lula da Silva’s commitment to fix a ballooning budget deficit sent the real into a tailspin last month, with the nation’s central bank spending some $20 billion in reserves in two weeks to defend the currency.
Real stability was ultimately achieved more from dollar weakness rather than from BCB policy action, Wells Fargo’s McKenna said. He expects fiscal dominance concern in Brazil to linger for at least the next few years leading into elections in late 2026. In Mexico and Colombia, rising budget deficits could be accompanied by the risk of inflation that becomes unanchored, even as prices are only creeping up so far, he added.
The Latin America debt crisis in the early 1980s and the Asian financial crisis in the late 1990s has improved the reaction function of emerging market policymakers. Latin America’s central banks proactively hiked interest rates starting in 2021 to combat inflation, doing so even ahead of major developed market peers. However, the resurgence in price pressures is coming in the way of further rate cuts at a time when heavy expenditures incurred by governments during the pandemic is sending alarm bells ringing on the fiscal side.
Thailand’s debt-to-gross domestic product has risen to 55% in 2023 from 34% in 2019, according to the latest data from the International Monetary Fund. China, Chile, Colombia and Poland are also seeing a similar trend.
“Fiscal dominance has become an important discussion point among EM investors,” Citigroup strategists including Luis E. Costa and Rohit Garg wrote in a note in December. Central banks in EMs such as Hungary, Poland, Brazil, and Mexico have recently mentioned fiscal risk as a reason for caution on their monetary policy stances, as per the note.
What to Watch
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Bank of Korea’s rate decision on Thursday will be closely monitored after the central bank unexpectedly cut rates at its previous meeting in November. Bank Indonesia and National Bank of Poland’s rate decisions are due Wednesday and Thursday, respectively
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China will release fourth quarter GDP, industrial production, retail sales and fixed asset investment figures on Friday, with any unexpected downside surprises to raise expectations for more monetary policy easing
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Investors will be watching for signs of inflation as India, Hungary, Poland, the Czech Republic and Argentina release CPI data
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