Inflation-adjusted interest rates are still too low indeveloping nations for Citigroup Inc. and Goldman Sachs Group Inc.to foresee an end to the worst emerging-market currency selloff in five years.

One-year borrowing costs in Turkey are 3.6 percent, less thanhalf of the average in the three years before the 2008 globalfinancial crisis, even after the central bank doubled its benchmarkrate last week, according to data compiled by Bloomberg. The realyield for Mexico is almost zero, while South Africa's is 1.4percent, compared with an average of 2 percent over the pastdecade.

Central-bank rate increases in Turkey, India, and South Africa last week failed to contain January's 3percent selloff in emerging-market currencies. Citigroup saysyields aren't high enough to attract the capital needed to financecurrent-account deficits in some of those nations. Competition forcapital is intensifying, with the Federal Reserve paring monetarystimulus, while the International Monetary Fund is calling for“urgent policy action.”

“When you have low real rates and try to finance yourcurrent-account deficits, it usually won't work,” Dirk Willer, aLatin America strategist at Citigroup, the second-largest currencytrader, said in a phone interview from New York on Jan. 31. “If theU.S. is repricing for higher rates, it's very difficult for you toget away with lower rates. South Africa and Turkey are not safeyet.”

Global funds pulled $6.3 billion from emerging-market stocks inthe week through Jan. 29, the biggest outflow since August 2011,according to Barclays Plc., citing data from EPFR Global. More than$12 billion has fled the funds this year, already approaching2013's outflow of $15 billion.

One-year real yields in developing economies, based on thedifference between interest-rate swaps and consumer-priceinflation, are about 1 percent, according to Goldman Sachs. Whilerising, the rates are lower than the average of about 2 percentfrom 2004 to 2013, a model at the New York-based bank shows.

Turkey's real yields may come under further pressure after areport showed today that the nation's annual CPI accelerated to afaster-than-anticipated 7.48 percent in January, from 7.4 percentthe previous month.

Raising Rates

Turkey's central bank raised the benchmark one-week repurchaserate to 10 percent from 4.5 percent at an emergency meeting on Jan.28, a day after the lira fell to a record 2.39 per dollar. Whilethe decision has helped the currency rally to 2.2631 as of 8:34a.m. New York time, it's still down 5.1 percent since Dec. 31, theworst start to a year since 2009.

South Africa's rand weakened to a five-year low of 11.3909 perdollar on Jan. 30, even as the central bank unexpectedly raisedinterest rates by a half-percentage point to 5.5 percent. Thecurrency declined 5.9 percent this year to 11.1451 per dollar.India's rupee has fallen 1.2 percent as central bank GovernorRaghuram Rajan surprised analysts by raising the repo rate to 8percent.

Argentina's government allowed the peso to devalue by 19percent in January as private banks boosted deposit rates. InHungary, the central bank bucked the trend, reducing the benchmarkby 0.15 percentage point to a record 2.85 percent on Jan. 21. Theforint tumbled last week to a two-year low of 314.23 per euro.

“If policy makers don't respond appropriately to signals fromthe market, and very few in EM [emerging markets] have done soconvincingly so far, then asset prices continue to pressure theeconomy directly,” Manoj Pradhan and Patryk Drozdzik, London-basedeconomists at Morgan Stanley, said in a client report on Jan 27.“At extreme times, this results in a sudden stop” in capital flows,they wrote.

The interest-rate increases are a reversal of the trend over thepast five years, when the Fed's monetary stimulus boostedinvestment around the world and allowed central banks in developingcountries to cut borrowing costs. Cheap money encouragedconsumption, widening trade deficits and fueling inflation.

Turkey's shortfall in the current account, the broadest measureof trade and services, amounts to more than 7 percent of its grossdomestic product, making the nation more reliant on foreigncapital. Brazil's consumer prices stayed above the central bank'starget since August 2010, eroding the competitiveness of theeconomy.

The real interest rate for Mexico is 0.1 percent, compared withan average 2.4 percent over the past decade, according to datacompiled by Bloomberg. At 24 percent, Argentina's deposit rates are4 percentage points below the annual inflation that oppositionlawmakers reported.

Now that the Fed is withdrawing the stimulus, the interest rates aren'tenough to compensate for the risk of putting money into emergingmarkets, according to Goldman Sachs. The U.S. central bank announcedJan. 29 plans to pare its bond purchases by another $10 billionto $65 billion.

“For many EMs, moving to a sustainable pace of growth andreducing external imbalances requires a combination of weakercurrencies and higher rates,” Goldman Sachs strategists led byKamakshya Trivedi wrote in a Jan. 30 report titled “It Ain't Over'til It's Over.” “In most places, real rates are only justnormalizing from extremely low levels.”

Rout Spillover

The rand, lira, and real will weaken further, while the selloffmay spill over to currencies with “stronger fundamentals” includingthe Mexican peso, Hungarian forint, and South Korean won, accordingto Trivedi.

A Bloomberg customized gauge tracking 20 emerging-marketcurrencies has fallen 3 percent this year, making the worst startsince 2009. The index has tumbled 10.4 percent over the past 12months, bigger than any annual decline since it slid 15 percent in2008.

The premium investors demand to hold emerging-market local-currency debt over five-year U.S. Treasuries increased to5.71 basis points, the highest since June 2012.

“The market will have to start differentiating those countrieswhich have already experienced a significant exchange-rateadjustment and those countries where the central banks would ratherenjoy lower interest rates for longer,” Anders Faergemann, a seniorportfolio manager at PineBridge Investments LLC in London, said inan Jan. 31 e-mail.

The IMF said Jan. 31 that some developing countries need to takeaction to “improve fundamentals.”

A decline in U.S. Treasury yields last month provided littlerelief for emerging-market currencies as China's $4.8 trillion ofshadow banking debt raised concern about the growth outlook for acountry that buys everything from Chile's copper to Brazil's ironore. Exports from developing countries will grow 5.8 percent thisyear, compared with an average 7.3 percent over the decade through2013, according to the IMF forecast.

The lack of export growth means that raising interest rates tocut consumption and imports is the only way for countries such asTurkey and South Africa to reduce their trade deficits, accordingto David Lubin, the head of emerging-markets economics atCitigroup.

Higher interest rates, in turn, will erode corporate earningsand slow economic growth, dimming the allure of their currencies,said Lubin.

“Having 'won' tighter monetary policy from these countries, themarket is now faced with a new problem,” Lubin wrote in a Jan. 30client note. “How to price these countries' currencies when theirgrowth outlook has taken a turn for the worse? And so, it isdifficult to call an end to currency adjustment in EM.”

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.