Two distinct phases have characterized the recent movement of emerging market currencies. The first phase was a sharp decline when the crisis first occurred, as capital flight into the safety of the dollar led to a significant depreciation of emerging market currencies vis-à-vis the dollar. This was led by Latin American economies, especially Brazil and Chile, but also to a lesser extent East Asian economies (the Singapore dollar, for example, depreciated 12 percent between September 2008 and March 2009, and the Korean won fell by a massive 35 percent). In the second phase, however, EM currencies reversed direction as the risk trade returned and capital flowed into emerging markets in search of yield. This has led to a steady appreciation of most emerging market currencies---an ironic "reward," if you will, for their pursuit of prudent macroeconomic policies both before and after the crisis, since appreciation has had the undesired effect of reducing their export competitiveness in a time when their economies are trying to recover from the aftermath of the crisis. The two distinct phases can be seen across a broad range of EM currencies, as detailed in the figure below.
Although this exchange rate pressure has led some countries respond with the limited imposition of capital controls (Brazil imposed a 2% tax on portfolio inflows in October 2009, Taiwan introduced limited controls in November 2009 and is thinking of more, and India hinted at the possibility), EM governments have by and large resisted such controls, having experienced the real benefits of floating rates during the crisis period (most notably in the absence of speculative attacks). However, such foreign exchange pressure is not entirely benign: EM central banks concerned about the export competitiveness of their economies may hesitate to move toward greater policy normalization through raising their interest rates, for fear of encouraging further portfolio capital inflows (which would lead to more currency appreciation). This can complicate the execution of an already difficult balancing act for these central banks, which are looking to both keep a lid on inflation, while keeping their respective economies humming along.
What do readers think? Is our concern with the policy complications overblown? Or are the benefits of avoiding currency crises sufficiently great to merit a little short-term adjustment pain?