Central Banks Try to Bolster Their Currencies. It’s Not Always Working
Some emerging-market central banks started dipping into roughly $6 trillion reserve stash in June reversal
Emerging-market central banks are tapping a roughly $6 trillion stash of foreign reserves as they struggle to contain deepening currency declines.
Policy makers across the developing world built up foreign-exchange reserve buffers over the past year, capitalizing on investor interest in higher-yielding emerging market assets as global growth remained sanguine. In the first five months of 2018, the central banks added $114 billion to their reserves, the fastest pace of accumulation since 2014, according to data released this past week by the Institute of International Finance.
That has reversed over the past month as emerging markets face a stronger U.S. dollar and escalating trade tensions that have pummeled their currencies, stocks and bonds. Emerging-market central banks used roughly $54 billion in foreign reserves in June, according to preliminary forecasts from research firm Exante Data.
Reserves are just one tool central banks use to influence exchange rates, and analysts say it isn’t always the most effective one. Policymakers can also adjust government borrowing costs--tightening or loosening the flow of money throughout the financial system--and enact regulations that keep money from leaving the country.
Still, the reserve stockpile--which remains near the highest level since 2015--suggests that emerging markets are better positioned to handle the market volatility that has accompanied the rising dollar since mid-April. In the past, emerging market economies short on foreign reserves have struggled to service dollar-denominated debts and contain inflation with a weakened currency.
A basket of emerging-market currencies tracked by MSCI Inc. has fallen 3% this year, pressured by the resurgent dollar, higher U.S. interest rates and trade tensions. The currencies of Argentina, Turkey and China have been hit especially hard, spurring those countries’ policy makers into action.
After one of the yuan’s worst months on record in June, China’s central bank is facing pressure to revive the kind of interventions that helped it stem a decline in the yuan in 2015 and 2016.
In recent weeks, the People’s Bank of China has pledged to keep the exchange rate stable while at least one state-owned bank has bought yuan to help support the currency, The Wall Street Journal reported. Those moves helped stabilize the yuan; it slipped 0.3% last week against the dollar after a 3.2% loss in June.
China’s reserve stash played a key part in arresting a decline in the yuan after the central bank devalued the currency in 2015, economists say. Beijing blew through nearly $1 trillion in reserves while it also tightened capital controls to keep citizens and companies from taking money out of the country.
It still has more than $3 trillion in official reserves it can use to help prop up the yuan.
“China has more reserves than anyone in the world,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics. “The question is, what do they want? If they want to stop this, they can stop this.”
Other central banks have also been using foreign exchange reserves to help stabilize markets. Brazil has spent nearly $44 billion on market intervention this year, with most of that conducted in derivatives markets, according to data from Exante. India has spent around $17 billion attempting to prop up its currency.
Benn Steil, a senior fellow at Council on Foreign Relations, said that the impact of those sales is often short-lived.
“Each central bank could sell dollars for local currency to push their currencies up, but only to the extent that they have sufficient dollar reserves, said Mr. Steil. He added: “Such action is often ineffective if not followed by interest-rate rises.”
Brazil’s currency, the real, was down nearly 14% on the year through Friday, while the Indian rupee was down 7.1%.
Argentina has proved an extreme example in the limits of currency reserves, which can also be used to cover the costs of things like debt repayment and imports. Argentina blew through more than $10 billion in reserves in April and May, according to IIF, in a largely unsuccessful attempt to stop a plunge in the peso. Facing dwindling reserves and upcoming payments on dollar debt, the country in June secured a $50 billion credit line from the International Monetary Fund. The peso has recovered nearly 4% this month but remains down 34% for the year.
Whether central banks will continue to deplete their currency reserves depends in part on the path of the U.S. dollar. The greenback rose 5% against a basket of peers tracked by The Wall Street Journal in the second quarter, its first gain in more than a year.
But some analysts believe the dollar’s rally could soon unravel if U.S. growth slows and trade uncertainties deter some investors from U.S. markets.
“A lot of this will depend on how emerging-market central banks view the trajectory for the dollar,” said Sonja Gibbs, a senior director of global capital markets at IIF. “If you believe the dollar’s recent strength is temporary, you may try to ride it out.”