BANKING & FINANCE
Sentiment-driven sell-off likely to hurt all emerging market currencies
Non-resident portfolio flows to EM, where positioning build-ups in certain countries, can still be a channel for contagion, even in the absence of meaningful macro imbalances. We find that South Africa, Lebanon, Egypt, Colombia, Peru and Indonesia are potentially exposed to this ‘concentration’ risk’.”
Robin Brooks | Managing director and chief economist at the IIF
The strength of economic fundamentals will be a defining factor in the impact of a potential ‘contagion’ or the spread of decline in currencies on most emerging market currencies, according to analysts.
As the ‘taper tantrum’ [massive outflow of forex from emerging markets in 2013, when the Fed stopped monetary stimulus] happened, it was the ‘fragile five’, a term coined by a Morgan Stanley analyst to denote a group of countries that comprised Turkey, South Africa, Brazil, India and Indonesia that suffered the most from capital outflows.
The fragile nature of these economies remains largely unchanged as their weaknesses relating to macroeconomic conditions have not changed much or rather have worsened from 2013, although in varying degrees.
Most of these countries are laden with large external debts coupled with weak banking sectors, bulging budget deficits, current account gaps, substantial shortterm foreign currency debt and inadequate forex reserves.
Non-resident portfolio flows to EM, where positioning buildups in certain countries can still be a channel for contagion, even in the absence of meaningful macro imbalances.” Robin Brooks (above) | IFF managing director and chief economist
Double the debt
Concerns over trade wars, lower expectations for global growth, and the withdrawal of central bank stimulus have fed concerns over the stability of emerging market currencies.
According to data from Bloomberg, total emerging market borrowing increased from $21 trillion (Dh77 trillion), or 145 per cent of their gross domestic product (GDP), in 2007 to $63 trillion (210 per cent of GDP) in 2017. Borrowings by non-financial corporations and households have jumped.
Since 2007, the foreign currency debt of these countries doubled to around $9 trillion.
Some commentators say, when the sentiment-driven sell-off kicks in, most investors will treat the emerging markets as a single universe and the impact on currencies and asset prices will be unidirectional. The strengthening of the dollar, rising US interest rates and weak domestic conditions are making portfolio investors nervous about emerging market currencies and asset classes.
A pickup in portfolio investment outflows is hurting emerging market currencies. Sentiment towards emerging markets is deteriorating — and the scope for financial contagion increasing — because of technical factors stemming from a surge in capital inflows over the past two years, especially last year.
Data from the Institute of International Finance, which tracks financial flows, showed emerging equities accounted for all inflows, raking in $7.1 billion, while debt markets suffered $4.8 billion of outflows, their first such loss since June.
The IIF believes that as in the past, portfolio outflows are likely to emerge as a key channel for the currency crisis extending to emerging markets.
“Non-resident portfolio flows to EM, where positioning buildups in certain countries can still be a channel for contagion, even in the absence of meaningful macro imbalances,” said Robin Brooks, managing director and chief economist at the IIF.