Russia's currency crisis poses risks to other emerging markets
The rouble's volatility has turned deteriorating sentiment into a sharper, broad-based sell-off that is even affecting oil importing countries
In August 1998, Russia announced it would devalue the rouble and default on its domestic debt. The crisis sent shockwaves through the global financial system and led to the collapse of Long-Term Capital Management, a US hedge fund.
The fact that parallels are now being drawn between the currency crisis that Russia is suffering and the country's 1998 default speaks volumes about the severity of the turmoil that has engulfed Russia's financial markets and led to sharp declines in other emerging market assets.
On Tuesday, the rouble fell 11 per cent against the US dollar in intraday trading following an emergency 6.5 per cent interest rate undertaken by Russia's central bank just after midnight. While it eventually pared some of its losses and strengthened sharply on Wednesday after the central bank unveiled measures to forestall a liquidity crunch in the banking sector, it has fallen 20 per cent this month mainly because of the collapse in oil prices.
Russia's currency crisis has turned a deterioration in sentiment towards emerging markets into a sharper and broad-based sell-off - even in those countries that are net oil importers.
In a sign that investors are less discriminating about countries than they were just a few weeks ago, the Indian rupee and the Indonesian rupiah - two currencies that have proved extremely resilient partly because of the countries' oil-importing status - have fallen 2.3 per cent and 2.1 per cent since December 5.
Moreover, the Mexican peso - which despite the country's oil-exporting status is considered to be one of the most stable emerging market currencies because of the economy's relatively sound fundamentals - has fallen 4 per cent this month and is at its lowest level against the greenback in more than five years.
The more vulnerable currencies have suffered sharper declines. The Turkish lira and the South African rand have fallen 5 per cent and 4.8 per cent respectively this month.
This week provided a foretaste of what could be in store for emerging markets if Russia - one of the most important developing economies in financial, economic and geopolitical terms - succumbs to a full-blown financial crisis.
The threat of financial contagion in developing economies looked and felt more menacing this week.
Even though oil prices rallied on Wednesday, the other big concern for emerging markets - the risks stemming from an anticipated tightening in US monetary policy - will be as, if not more, important in shaping sentiment towards developing economies.
For the time being, the US Federal Reserve appears to have done enough to reassure markets at a particularly sensitive time for so-called risk assets .
On Wednesday, the Fed dropped its forecast that it would keep interest rates low for a "considerable time" while stressing that it would be "patient" in judging when to begin tightening policy.
The Fed's new language, coupled with a clarification from its chairwoman Janet Yellen that the central bank does not expect to raise rates until next April at the earliest, was perceived as dovish by traders and analysts.
Emerging Asian stocks rallied yesterday morning, while the rupiah and the rupee immediately strengthened. Turkey's currency, moreover, which is arguably the most accurate gauge of emerging market sensitivity to US monetary policy given the country's heavy reliance on external finance, firmed against the dollar.
Although it is difficult to disentangle the effects of a modest rally in oil prices - Brent crude rose from under US$59 a barrel on Tuesday to just over US$61 yesterday - from the reassuring statements from the Fed, the threat of contagion from Russia has, for the time being, been contained.
Still, it is far too early to dismiss the threat posed by the rouble crisis.
Volatility is the watchword when it comes to Russia and there is ample scope for the rouble to resume its steep fall given the downward pressure on oil prices and the loss of confidence in Russian monetary policy.
Emerging markets investors would be well advised to tread carefully.
