EM CURRENCIES A manifesto for a new world order

Post on: 10 Июль, 2015 No Comment

11/11/2010 | Ousmène Mandeng

The G20 should establish a facility to unwind unwanted holdings of dollar-denominated international reserves in order to depreciate the greenback and internationalize emerging market currencies, writes Ousmène Mandeng at Ashmore Investment Management

The G20 summit in Seoul must make urgent progress in tackling frictions in the global exchange rate system. Fears over global currency wars, calls to adopt current account targets or to back some form of gold standard are symptoms of the same cause: the breakdown in the international monetary system.

Under the shadow of this risk, the G20 cannot rehash old promises or customary clichs. For international investors, meanwhile, a reform of the global monetary system would require a fundamental reassessment of whether existing portfolio allocation strategies, both strategic and tactical, remain valid.

Emerging markets are projected to represent about half of world output at market prices within the next 10 years. It seems inconceivable, therefore, that the increasing economic weight of developing markets will not also be accompanied by a rise in developing world currencies in global reserve management, trade, financial markets and political diplomacy.

The hegemony of the dollar has remained a relic  some would argue a barbarous relic  of the post-Bretton Woods era. There is, therefore, increasing doubt about the desirability and feasibility of preserving a dollar-based system.

The US Federal Reserves decision to adopt another round of quantitative easing  amid protests from emerging nations faced with the threat of hot money inflows  has once again thrown into sharp relief the fundamental flaw in the international monetary system.

At its heart is the beggar-thy-neighbour impact of US monetary policy on international liquidity conditions. The US Fed is a national entity and is unlikely to subordinate its national policy objectives to the needs of the international economy. Quantitative easing has, thus, strengthened the case for reform of the international economic system.

Rather than relying on a few currencies, the international economy should rely on many. The aim should be to integrate emerging markets currencies into the international monetary system.

The G20 could provide a framework using its central banks for the internationalisation of emerging markets currencies. Acting collectively, the G20 can thus help overcome current first-mover problems  the fact that many central banks remain adverse to adopting new currencies due to reputational concerns; and other institutional constraints  prevailing restrictions on access to currencies  that are preventing widespread adoption of emerging markets currencies by central banks today.

A STERLING PLAN

Following the example of the pound sterling during the 1960s and 1970s, the G20 could agree on a facility to unwind unwanted holdings of dollar-denominated international reserves and diversify into a broader set of currencies. Sterling was subject to coordinated support from central banks to allow for an orderly reduction of central bank sterling balances to reduce the role of sterling as a key reserve currency.

The G20 could use a similar approach today to swap central bank dollar reserves for emerging markets assets to facilitate a gradual integration of emerging markets currencies. Central banks through emerging markets asset purchases and direct intervention in foreign exchange markets could, thereby, also support a gradual depreciation of the dollar. Central banks that have been the main agent to facilitate perpetuation of dollar dominance could, thus, become the main engine to allow proliferation of other currencies. The currencies that are of immediate interest are the BISMARCK currencies (B razil, I ndia, S outh Africa, M exico, Saudi A rabia, R ussia, C hina and K orea).

The G20 central banks may point to a lack of investable assets denominated in emerging currencies, as a sign that these currencies will fail to gain traction in international reserve management. This is only partially true. Emerging markets do offer today substantial investment opportunities, according to benchmark government bond indices, a key driver for official asset allocations. The JP Morgan Government Bond Index Emerging Markets (GBI-EM) has a market capitalisation of $1.4 trillion. While much smaller than the GBI United States, it is bigger than the GBI Germany or the GBI France. The aim would not be to substitute the dollar but to establish a truly international monetary regime to reduce the dollars global dominance, and by natural extension, the impact of US monetary policy on the international economy.

Emerging markets, meanwhile, need to do more to make their currencies more accessible to foreign investors and consumers. Sadly, the hostile economic and political climate and moves at financial protectionism fly in the face of the medium to long-term goal of internationalizing emerging currencies.

Many emerging markets have adopted, or are considering, capital controls to prevent more access to their currencies. But in the end nature will take its course: emerging markets will have to deal with a permanent positive capital shock due to underlying structural factors, as income levels, productivity and GDP expand. Capital controls that may work for more cyclical shocks would not be the right tool.

No matter the outcome at the G20 summit, the ascent of emerging markets currencies wont be derailed. Against this backdrop, most international portfolios remain substantially  and inexcusably  underweight emerging markets.

The possible adoption by the official sector of emerging markets currencies and, hence, integration of emerging markets currencies into the international monetary system would constitute a major event that is set to transform this asset class. It may represent the most important development for international asset allocation yet.

Ousmne Mandeng is head of public sector investment advisory at Ashmore Investment Management.