WWRR Vol.2.015

2019 Global Economic and Market Outlook
Fig 63 Turkey, Argentina, Indonesia, and Colombia have recently had the highest current
account deficits to finance, between 3.5% and 6% of GDP
Source: IMF, Macquarie Macro Strategy.
In the case of South Africa, the problem is likely a “twin deficits” problem, where the
imperative to save more (and “self-finance”) is impeded by a large fiscal deficit at the
federal government. The rating agencies have taken notice, of course. S&P said that the
ratings remain constrained by weak economic growth, the large fiscal debt burden, and sizable
contingent public liabilities. SA was already downgraded three times since 2012, so S&P may wish
to give SA some breathing room.
In Asia, current account watchers and rating agencies used to keep a much closer eye on
India and Indonesia, because these countries used to have larger current account deficits.
But this vulnerability has declined somewhat since then. India’s current account deficit has shrunk
to less than 2.5% of GDP (from 4.8% in 2013). Indonesia’s has dropped to less than 3.0% (from
4.0%). However, the deficits that remain in India and Indonesia are structural in nature (like
Turkey’s), and not easy to close through relative price adjustments alone. Substitutes will be hard
to find for foreign oil in India, and there are good reasons why policymakers have shied away from
re-imposing gold import restrictions there. In Indonesia, coupon payments made to many foreign
bondholders are a source of ongoing outflows in the external accounts. The same goes for
Indonesia’s dependence on foreign-owned maritime freight transport.
Of course, central banks can sometimes temporarily stem outflows of foreign capital through the
use of their reserves or through their interest-rate setting policies, which can be used to influence
short-term capital flows. In this regard, central banks that can or are willing to intervene or to
raise interest rates can temporarily subdue the urge of capital the urge to exit, until other
adjustments are made.
Usually, central banks facing high growth or low domestic debt ratios are in the best
position to take such steps to tighten domestic liquidity. However, all central banks must also
take care to not allow their interest rates to fall too far, either, as this could trigger capital flight.
Indeed, the urge to hedge increases following sudden and sharp FX declines, and this potentially
amplifies any weakness that develops. We note that even in periods of stable financial markets,
bondholders may get paid to hedge away their FX risk, which in turn hurts the exchange rate.
Thus, with real interest rate differentials (vs. the US) low in South Africa, Korea, Turkey, and
Chile, those markets remain susceptible to flight. Russia, on the other hand, has displayed a
willingness to allow real interest rate differentials to rise since the “taper tantrum” of 2013. Mexico
has too, although further hikes may be warranted by the stresses on the MXN put in place by the
new administration’s policies, rather than by higher interest rates abroad.
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