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Emerging markets move to halt currency slide

Turkey’s central bank headquarters is seen in Ankara.

Umit Bektas/Reuters

Turkey's central bank moved to bolster its embattled currency with a shock hike in its overnight lending rate as a surge of capital outflows continues to roil emerging markets from Argentina to South Africa.

Saying it was concerned about "macroeconomic stability," Turkey dramatically raised its lending rate on Tuesday to 12 per cent from 7.75 per cent, a jump much larger than markets had anticipated.

Earlier in the day, the Reserve Bank of India also acted forcefully to protect its currency and curb inflation. In a surprise move, the bank boosted interest rates.

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The two central bank moves come amid broader concerns about the health of emerging markets, as recent Chinese GDP numbers hint that the world's second-biggest economy is slowing down and the U.S. Federal Reserve Board eases its bond-buying stimulus measures, prompting investors to pull money out of riskier emerging markets and flee to the United States for safer returns.

Since Dec. 31, the MSCI Emerging Markets index has lost roughly 7 per cent, compared with a 3.4-per-cent decline in the MSCI World Index, according to Bloomberg. While some investors fear this may signal the start of a broad emerging markets downturn, most economists caution that the turmoil is related to specific conditions within countries such as Turkey, South Africa and Argentina.

"We are seeing that the events in the past few days … the major component has to do with problems in a subset of emerging market countries," Jose Vinals, director of the IMF's capital markets department, told reporters in Washington, according to Reuters.

The Turkish central bank in Ankara made its aggressive move after an emergency meeting on Tuesday, and despite warnings from Turkish Prime Minister Recep Tayyip Erdogan that higher borrowing costs could dampen the country's economic growth.

Turkey's financial markets have been falling since a corruption scandal broke last month, ensnaring several cabinet members. The country's benchmark equity index recently reached an 18-month low and is down more than 20 per cent over the past year.

In India, the Reserve Bank of India cited current uncertainty in emerging economies and said there was a "clear potential risk" of "financial market contagion" because of the slowdown in China and uneven growth across Europe and Japan. On Tuesday, the bank raised its benchmark rate by 25 basis points to 8 per cent, but hinted that further monetary tightening might not be necessary if retail inflation eased. (A basis point is 1/100th of a percentage point.)

Economists said the rate hike was intended in part to protect the rupee. India's currency sank by 2 per cent in the week leading up to Tuesday's decision. It had already shed 11 per cent over the summer of 2013, when emerging market currencies from Indonesia to Turkey suffered steep declines triggered by the Fed's decision to taper its stimulus program.

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The current rout in emerging market currencies and equities is more uneven than the across-the-board slide that occurred in the summer, which some economists suggest is evidence that the chaos is restricted – for now – to specific countries, particularly those with current-account deficits.

There are few similarities between Argentina, which saw its peso lose 11 per cent in one day last week after the government devalued the currency, and South Africa, where the rand has fallen in tandem with prices for gold and other commodities.

Some investors interpret the rate increases in Turkey and India as a welcome sign that many emerging markets will move decisively to prevent financial contagion.

"While the sharp increase in interest rates will unfortunately slow the Turkish economy in the short-term, it is a very welcome first step in returning Turkey to economic orthodoxy and restoring confidence," said Sam Vecht, a portfolio manager at Blackrock Emerging Europe Investment Trust, in an e-mail. "The actions being taken by central banks in diverse countries such as Brazil, India and now Turkey should help allay investor concerns."

With files from Bloomberg News

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