Rand not free from Turkish contagion
SA one of emerging markets most at risk from investor flight
● There is no reprieve in sight yet for the rand and other emerging-market currencies battered this week in the fallout over Turkey’s economy crisis.
Instead, SA is one of several countries considered vulnerable to contagion from Turkey, after investors began to dump riskier emerging-market assets amid negative sentiment over Turkey’s economic blunders. These include President Recep Tayyip Erdogan taking control of the central bank. The country also has high foreign currency-denominated debt, and is facing deteriorating trade and political ties with the US.
The strain arising from global liquidity as global interest rates rise further this year, primarily in the US, is expected to intensify the pressure on emerging-market currencies.
The pummelling these currencies took this week sparked concern that central bank governors in these countries may have to raise interest rates to contain runaway inflation.
The Turkish lira led declines to record lows, while the rand has battled to recover after weakening beyond R15/$ to levels last seen before Cyril Ramaphosa’s election as ANC president in December.
SA has a fragile economy, which is under scrutiny, especially because of its heavy reliance on foreign portfolio flows. But other emerging markets are also under pressure.
Argentina has a larger proportion of foreign-currency debt exposure as a percentage of GDP than its emerging-market peers, while Mexico, Brazil and Russia have a significant amount of foreign-currency debt as a percentage of GDP in the private sector.
Carsten Hesse, European economist at investment service group Berenberg, said: “Argentina is probably the most vulnerable one, followed by SA, Brazil and Russia.
“The contagion risk increases for countries that suffer from similar problems as Turkey. Countries that have high twin deficits and have a central bank that is not fighting inflation, or have a political dispute with the US and are having high foreign-exchange loan exposures, are in danger of suffering from the Turkish crisis,” Hesse said.
More-developed emerging markets such as the Czech Republic, Poland and Hungary, and some larger Asian emerging markets, were less exposed to the Turkish challenges.
“But the big risk here [in particular in China] is the tit-for-tat tariff threats that have a very negative impact on business sentiment,” Hesse said of the trade row between the US and China, which has resulted in SA’s steel and aluminium exports being subjected to higher US tariffs.
Investors’ risk aversion is exacerbated by the prospect of higher interest rates later this year as quantitative easing, which has propped up the US economy since the 2008/2009 recession, is expected to end.
Although reinvestment in emerging markets would continue, it was the pace of the tightening of US interest rates and the outcome of the trade war that economists were closely watching, Hesse said. “We believe that emerging markets overall are better positioned to handle a crisis … than during the previous crises.”
The dollar continued to rally as capital retreated to the greenback as an investment safe haven. However, once the threat of a massive increase in tariffs and sanctions by the Donald Trump administration disappeared, the risk-on sentiment would return, weakening the dollar. “We expect this is likely to happen over the coming months,” Hesse said.
The Institute of International Finance said this week it had signalled the growing risk for emerging markets for some time, particularly multiple shocks that include the incremental rise of interest rates in the US, Europe and Japan, and trade tensions that have spilt over into the devaluation of the currency of China — the largest emerging market.
The institute warned earlier this year of the material overvaluation of the Turkish lira due to a rapid widening of the current-account deficit. “We continue to see emergingmarket vulnerability on a broader scale, reflecting the rapid build-up of nonresident portfolio flows in recent years, with a heavy concentration in certain countries.
“This concentration risk is a key conduit for contagion,” the institute said, and this was partly why many emerging-market currencies were worse off now compared to the dollar than during the so-called 2013 “taper tantrum” — when the US signalled the first interest rate-hiking cycle in nearly a decade.
The institute said SA, Indonesia, Lebanon, Egypt and Colombia faced the greatest threat from “concentration risk” as a result of “hot money” compared to slower inflows such as foreign direct investment, which are considered genuine flows due to their relative longevity.
In SA’s case, foreign inflows have kept economic growth ticking at a time when the government is unable to stimulate growth.
Moody’s warned this week that “growth this year is expected to be lower than the government’s own estimates, weighing on tax revenues, while the public sector wage agreement in June also brings extra unbudgeted costs”.
It said rising interest costs “in the context of investors taking a more risk-averse stance towards emerging markets are a main risk to Moody’s fiscal forecasts, together with potential support to state-owned enterprises”.
Piotr Matys, a currency strategist at Rabobank, said the Ramaphosa administration was “quickly running out of time to strengthen its economic fundamentals”, given that emerging markets faced the prospect of an even stronger dollar and the further escalation of global trade tensions.
Should the rand weaken further, the Reserve Bank might have to step in and hike rates even when the underlying trend in economic activity was far from solid, as reflected in slow GDP growth of just 0.8% year on year in the first quarter, down sharply from 1.5% year on year in the fourth quarter of 2017, Matys said.
Inflation, at 4.6%, was “comfortably” within the central bank’s 3%-6% target range. But if inflationary pressures rose due to further currency weakness, “policymakers led by [Bank] governor [Lesetja] Kganyago will face a major dilemma of whether to raise rates at a time when the external backdrop does look challenging”, Matys said.
But for now, the question for emerging markets was for how much longer the dollar would rally.
Jameel Ahmad, global head of currency strategy and market research at FXTM, said: “There is a clear and prolonged ‘risk off’ attitude from investors towards emerging-market currencies, which is not being helped by the persistent buying of the dollar, which saw the greenback climb to its strongest level since June 2017.
“With all of the external headwinds that continue to rattle the global financial markets, now is not a good time to seek emerging-market currencies,” Ahmad said.