Possible Coordinated EM Intervention--Color Us Skpetical

The principal economic adviser to the Indian government has been quoted on the news wires suggesting the possibility of coordinated intervention by emerging market countries. Brazil was cited, though local central bank sources have denied it.

India's rupee has fallen almost 8% this month, its largest monthly decline in more than a decade and that includes the roughly 4.5% rebound in the past two sessions after the government indicated it will provide hard currency (via swaps) with the country's main oil importers. For its part, the central bank of Brazil has stepped up its swap operations to defend the real and hiked the overnight rate by 50 bp earlier this week. The real has fallen about 3.1% this month and that includes about a 5.3% recovery since August 21.

The Indonesian rupiah is the weakest performer, losing 8.1% against the dollar this month. The Turkish lira lost 5.2%, while the South African rand depreciated by 4.5%. Reports tracking both mutual funds and ETFs show investment funds still leaving emerging markets.

Many emerging market countries, like Brazil and India show tighter linkages between depreciating currencies and inflation. Brazil did report stronger than expected Q2 GDP today (1.5% vs consensus of 0.9% after 0.6% in Q1). However, the growth challenges are evident in the expansion of only 1.9% over the past four quarters. Higher interest rates to defend a currency has clear limits.

Coordinating intervention is particularly difficult and even if there were willing partners, the operational logistics are particularly difficult. G7 coordinated intervention usually has focused on one currency pair, such as the dollar-yen or euro-dollar rates. To the extent that a participating central bank intervenes in another pair, say euro-yen, it is seen as diluting the operation. What currency pair should emerging market central banks intervene on, without diluting their firepower and effectiveness?

The dollar, euro and yen trade 24 hours a day. Coordinated intervention among the high income countries has often taken place during the US morning/European afternoon. Most emerging market currencies tend to be considerably more locally traded. Even if Brazil and India wanted to coordinate their intervention, the different time zone in which they operate make it more difficult.

Another issue that seems to argue against coordinated intervention by emerging market countries is the issue of what instrument to use. When the G7 intervene, the spot market is targeted. There is speculation from time to time about the use of options, but there is little concrete to rely on. Many emerging market countries use swaps and (like South Africa in the past) possible forwards, which has a less transparent impact on reserves.

Effective emerging market coordinated intervention is possible, even if difficult.  It would be more effective if it could be coordinated with foreign bond purchases by large reserve holders, such as China and the Middle East.  Assistance by Japan, who has the second largest reserve holdings, would also be helpful and could possibly suit the Abe government's domestic agenda of reflating the economy, and arguably weakening the yen.    However, this level of coordination is unlikely to be forthcoming any time soon due to both operational and philosophical/ideological reasons.