Central and eastern Europe’s rapidly expanding local currency markets, much lauded by the private sector and multilateral agencies alike, could be more of a curse than a blessing for the countries themselves, a top central bank official warned yesterday.
Boris Vujcic, deputy governor of Croatia’s central bank told Emerging Markets the rapid evolution of local markets did not bring “peace of mind” to the region’s monetary authorities.
“If you have well-developed local currency markets, there are more opportunities for speculation and shorting of the domestic currency, and that kind of volatility is a double-edged sword for monetary policy.” Although the monetary framework in Croatia is robust, he said, other emerging economies may not have sufficient foreign reserves to manage currency volatility.
The search for yield by global investors means capital markets across transition economies can expect continued growth. But the profusion of hedge funds poses a particular risk for emerging markets because “they are willing to take more risk than other players, and to exit quickly, which creates more instability,” Vujcic said.
Authorities across emerging Europe are less than enthusiastic to back the development of local currency debt markets for a number of reasons: foreign currency from oil exports, revenues from privatization, and anticipation of entering the euro.
Vujcic said he expects “limited” development in Croatia’s kuna bond market, “and then we will switch to the euro within a few years”.
The depth of local market development further east is also in doubt. Negative real interest rates in Kazakhstan mean that local currency bond markets in the central Asian republic will only draw interest from foreign investors. “Local pension funds will never accept returns below the rate of inflation,” said Grigori Marchenko, chairman of Halyk Bank of Kazakhstan, speaking at a capital markets forum yesterday.
The former central banker admitted that local exporters and import-competing businesses could suffer if the local currency appreciated on foreign investor demand. Kazakhstan has already experienced a similar effect as the tenge has soared with oil-related FDI, and it has put the government’s programme to diversify its economy “in doubt”. Local capital markets, in which local pension funds can invest, were crucial to develop long-term lending for investment and mortgages, he added.
The EBRD is firmly backing local currency market development in the countries where it operates. They are also necessary for many of the bank’s infrastructure projects, Steven Kaempfer, EBRD vice-president pointed out.
The bank’s rouble-denominated bonds in 2005 and 2006 met with strong investor demand because “Russia’s appreciating currency [because of oil exports] attracts international investors to all rouble-denominated instruments”, he told Emerging Markets.
A bigger problem is that “the highly technical legal requirements to put a functioning domestic market in place are not at the front of the minds of parliamentarians,” Kaempfer said.