LONDON Newly cheap currencies may soon start to boost emerging markets' exports but for many that will only soften the bigger blow of imported inflation and the higher interest rates needed to stabilize their exchange rates.
Currencies from the Indian rupee to the Brazilian real have lost 12-20 percent of their value against the dollar this year in a rout that has wiped billions of dollars off stock indices and put investors to flight right across emerging markets.
In those fallen currencies, policymakers are seeing the seeds of their salvation.
If economic recovery in China, the United States and euro zone stays on course, so will demand for cheaper emerging market exports, the reasoning goes, in turn shrinking the big current account deficits dogging countries such as India and Turkey.
"(Rupee) depreciation can be good for the economy as this will help to increase our export competitiveness and discourage imports," Indian Prime Minister Manmohan Singh said last week as the rupee crashed to new record lows against the dollar.
He should be right. Textbook economics dictates that a 20 percent currency deflation will be followed by an export boom, as local labor and input costs fall 20 percent for companies with dollar-based sales. That was what powered the emerging markets' turnaround after the 1997-2002 crises.
There are complicating factors this time around, though - not least the still-high oil price and the credit explosion that has taken over as the main growth driver for many economies, in particular for those with current account deficits.
The currency effect is starting to filter through to exports in some emerging markets: Latin American exports rose 2.2 percent year-on-year in July, after contracting an average 0.9 percent in the first half of the year, Capital Economics says.
Exports from South Africa jumped more than 10 percent in July while Brazil's farm exports rose strongly in the first three weeks of August as the real weakened.
Yet a range of investment banks including Goldman Sachs and Morgan Stanley have sharply cut their forecasts for emerging markets growth for this year and the next, reflecting pessimism about the extent of an export-led growth bounce.
"Absolutely, weaker currencies will help the export side. The problem is the currency and bond markets move much quicker than current account deficits," said David Hauner, head of EEMEA currency and debt strategy at Bank of America/Merrill Lynch.
"Net net, I would argue that the earliest you can hope to see an improvement is the end of this year."
EXPORT DEMAND VS DOMESTIC DEMAND
Developing economies should be able to take heart from purchasing managers indices (PMI) which clearly indicate a growth uptick in China, Japan and the West.
Historically, that helps developing economies, say UBS analysts, whose research shows emerging markets' exports are more closely correlated with developed PMIs than their own.
But Bhanu Baweja, head of emerging debt and currency strategy at UBS, points out that U.S. import demand - the biggest magnet for emerging manufacturers - is these days mainly in sectors that developing countries typically do not supply - heavy machinery and transport for shale gas production.
Besides, the slow-burn recovery has so far brought little new spending power to the average U.S. or European worker. Median U.S. weekly earnings in constant-dollar terms are up just 6 percent since 1995, while British real wages last year were at 2002 levels, official data in both countries shows.
Crucially though, an export-led recovery looks unlikely for countries that have been forced to tighten policy to defend their currencies because these steps are pushing up borrowing costs, potentially choking domestic credit and consumer demand.
Baweja notes that after the 2008 crisis, credit rather than exports became the main growth driver for many countries and this is now under threat.
"As U.S. rates rise, EM rates rise too so although exports may recover, domestic demand will slow and at the margin this second dynamic may be dominant," he says.
"It is unlikely that the strength of the export rebound will be strong enough to counter a decline in EM domestic demand."
"TWO EDGED SWORD"
Oil could be the game changer. Cheaper currencies mean factories pay more for imported components and raw materials - undercutting export competitiveness gains.
In Turkey for instance, where almost all energy is imported, a 10 percent lira fall boosts inflation 15-20 percent, BofA/ML calculate. So a big chunk of price competitiveness is given back to inflation over the following months, they say.
Indian exports too have barely nudged up despite two years of steady rupee depreciation. Moreover, with fuel heavily subsidized, every 1 rupee fall versus the dollar is estimated to increase India's subsidy burden by 80 billion rupees ($1.2 billion).
"A weak currency is a two-edged sword," said Philip Poole, head of strategy at HSBC Global Asset Management.
"If you take an economy like India, imports are rather inelastic and when the cost of oil goes up, that has an effect on the budget and inflation and a degrading impact on growth."
($1 = 66.1650 Indian rupees)
(Graphic by Vincent Flasseur and Joel Dimmock; Editing by Ruth Pitchford)