IEEJ： February 2014ｃ IEEJ 2014
○Special Bulletin

A Japanese Perspective on the International Energy Landscape (159)

February 7, 2014

Turmoil in International Financial Market under Rapid Depreciation of Emerging
Countries’ Currency
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan

Since early this year, turmoil in international financial and currency market has stemmed fromthe rapid depreciation of emerging countries’ currencies and attracted global attention. In January,
the Argentine peso depreciated rapidly, triggering financial and currency market turmoil. While theArgentine peso had been viewed as stronger than indicated by the economic reality and remained
under downward pressure, the Argentine authorities had supported the currency through peso-buying
and dollar-selling market interventions. But Argentine foreign currency reserves declined from $52.1
billion in 2010 to $30.5 billion at the end of 2013, and to around $20 billion at the end of January,leading market players to doubt that Argentine authorities could continue market interventions tosupport the peso. This induced a rapid peso decline.

The Argentine government is trying to defend the currency and fight inflation with interest rate
hikes that could dampen the economy further. Argentina had continued its economic growth by
expanding exports of commodities including soybeans, its mainstay product, amid a commodity
boom. As the boom has ended with doubts emerging about the Chinese market's growth potential,
however, various challenges and uncertainties about economic fundamentals have emerged inArgentina. Future developments are difficult to predict.

The Argentine currency's decline may fall short of attracting global attention as long as any
subsequent turmoil is limited to inside the country. The problem is that the impact can be expected tospill over to other emerging countries plagued with similar structural problems and expand further
into the world. In fact, the Argentine problem has already exerted downward pressure on thecurrencies of other emerging countries, such as Turkey and South Africa, and prompted theirmonetary authorities to raise interest rates. Fears have also emerged about the financial markets ofBrazil, India and Indonesia. These five countries are plagued with common structural problems,
including current account deficits, rapid inflation and high dependence on foreign funds for domestic
economic growth. They are therefore called the "Fragile Five."

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○Financial market fears in these emerging countries are attributable primarily to their respective
domestic fundamental economic problems, as explained above. From the global perspective,
however, we see the impact of a U.S. plan to reduce monetary easing by tapering the third
quantitative easing program. The growing U.S. economic recovery led the Federal Reserve Board to
decide late last year to gradually reduce monetary easing. The Fed is now steadily implementing thedecision. Under ultra-easy U.S. monetary conditions, investors have undoubtedly poured abundantmoney into buying various risk assets. The monetary easing reduction could prompt them towithdraw money from risk assets throughout the world.

In this way, a capital drawback from fragile countries has brought about the abovementioned
turbulence and turmoil. On the stock market, investors have enhanced their risk-off moves, causing arapid decline. As a result, stock market destabilization has spread from the abovementioned
emerging countries to the United States and the rest of the world. In this kind of trend, investors shiftmoney to less risky assets to avoid risks as much as possible. Due to such moves, the yen has risen
again, contributing to the Japanese stock market decline.

Amid the growing fears, the market direction remains uncertain. For the immediate future, themarket turmoil could deteriorate further depending on details and interpretations of key U.S.
economic indicators, including jobs data. Another focus of attention may be the immediate future of
the Chinese economy. China’s economic growth is expected to decelerate to a 7.0–7.5% range thisyear from 7.7% in 2013. In addition, shadow banking and financial product problems have been
cited as factors affecting the future Chinese economy. China and other emerging countries are
running out of “steam” after driving the global economy following the Lehman Shock, while seeing
the emergence of various destabilizing factors. The United States is recovering on the benefits of theshale revolution while its future recovery remains uncertain. In trying to anticipate whether thepresent global financial market turbulence and turmoil would end or deteriorate further, we must
keep a close watch on how the world’s first and second largest economies will perform.

The international financial market turmoil originating from emerging countries is important for
anticipating the future international energy market for several reasons. First, the turmoil can affectglobal macroeconomic trends and impact economic growth and energy demand. Second, the turmoil
could weaken demand for energy (and commodities) as well as global economic growth, given thatmost of the present global energy demand growth depends on expanding demand in emerging
countries. Third, such energy demand growth drop could be coupled with growing expectations of
medium-term energy supply growth to lower energy prices in the international market. Fourth, any
financial market turmoil could induce a capital flight from risk assets, which could be combined withchanges in energy and commodity market fundamentals to exacerbate price fluctuations. Fifth, if
international energy prices decline rapidly for the four abovementioned reasons, it may exert
negative impacts on the Middle East and Russia, which depend heavily on energy exports. Such2

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development could have various political, economic and geopolitical implications. We shouldclosely watch the future course of the present financial market turbulence and turmoil, including
their impact on the international energy situation.

Contact: report@tky.ieej.or.jp
The back issues are available at the following URL
http://eneken.ieej.or.jp/en/special_bulletin.html

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