LONDON - It's proving contagious.
First it was the central bank of
India. A day later, on Wednesday, its counterparts in Turkey and South Africa
followed suit in raising interest rates. But any hopes they had in seeing their
currencies stabilize appear to have been dashed, if the disappointing market
reaction is anything to go by.
Currencies in emerging economies have
been battered in recent days and weeks by a number of factors, including
concern over global growth and the U.S. Federal Reserve's decision to rein in
its money-creating stimulus. A lower currency has the potential to stoke
inflation by raising import prices -- controlling inflation is the primary
responsibility of central banks around the world.
India's central bank got the ball
rolling with its surprise decision Tuesday to raise its main interest rate by a
quarter of a percentage point to 8 percent. Though it justified the move in
terms of keeping a lid on inflation pressures, protecting the rupee is widely
considered to have been a key motive.
Those considerations were clearly
behind the decisions in Turkey and South Africa. The Central Bank of Turkey said it was raising its main overnight lending rate to 12 percent from 7.75
percent and more than doubling its one-week rate to 10 percent from 4.5
The bigger-than-expected increases
come after the Turkish lira hit a record low against the dollar on concerns
over growth, a police bribery scandal might destabilize the government, and the
change in the Fed's monetary policy.
Turkey, like other emerging economies,
has seen an influx of foreign investment over the past few years as the Fed and
other central banks have pumped the prime to shore up their economies. Now that
the Fed has begun reducing its stimulus, much of that money is expected to be
South Africa's central bank was clear
that the falling rand had a key role in its decision to raise its main interest
rate by a half percentage point to 5.50 percent despite concerns over growth.
"Inflation forecasts indicate the
possibility of being out of the target range for an extended period, largely
due to the impact of the depreciating currency," Gill Marcus, the South
African Reserve Bank's governor.
The motivation is clear, but will it
Some analysts are skeptical that
higher interest rates will be enough to stem the volatility and avoid a
destabilizing inflation trap. Recent experience, they say, is not encouraging.
"The history of using interest
rates to defend a currency usually ends in tears," said Neil MacKinnon,
global macro strategist at VTB Capital.
MacKinnon pointed to the experience of
Europe before the launch of the euro in 1999. Many currencies had been pegged
to each other in the so-called Exchange Rate Mechanism and when markets became
volatile in the early 1990s, central banks raised their interest rates to
support their currencies.
However, that came at a cost, most
notably in Britain. The government there left the currency pact after the Bank
of England splashed out billions of pounds and raised its main interest rate a
massive 5 percent in one day in a last-ditch -- and ultimately futile -- effort
to defeat the speculators.
If one day's reaction in the markets
is anything to go by, it will take some time before it becomes clear whether
the rate increases are working.
Despite an early lift, the Turkish
lira was struggling again, trading 3.8 percent lower on the day against the
dollar at 2.2633 lira. The South African rand was down 2.7 percent at $0.0890.