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LON­DON: Emerg­ing mar­ket (EM) in­vestors are try­ing to gauge whether a cur­rency cri­sis and the steep in­ter­est rate hikes be­ing used to fight it could turn into a broader slow­down and even re­ces­sion.

On Thurs­day, Turkey’s cen­tral bank at­tempted to draw a line un­der a lira col­lapse of al­most 40 per cent this year by hik­ing in­ter­est rates more than 6 per­cent­age points to 24 per cent.

Ar­gentina is strug­gling to shore up its peso, which has more than halved in value de­spite puni­tive in­ter­est rate rises to 60 per cent.

Other cur­ren­cies have been caught in the slip­stream, with In­dia’s ru­pee plumb­ing record lows and South Africa’s rand, Rus­sia’s rou­ble and Brazil’s real los­ing 15-20 per cent this year so far.

Signs are ap­pear­ing that months of mar­ket tur­moil are start­ing to take the toll on real economies. South Africa un­ex­pect­edly en­tered re­ces­sion in the sec­ond quar­ter of this year, Ar­gentina is pre­dicted to fol­low suit and Turkey is now widely fore­cast to ex­pe­ri­ence a hard land­ing over the next year.

So what is growth like in these coun­tries right now, what signs are there of a shock to busi­ness and con­sumer con­fi­dence and has the near sud­den stop in in­vest­ment flows seen 2019 eco­nomic fore­casts de­te­ri­o­rate markedly?

Pur­chas­ing man­ager in­dexes have suf­fered sharp drops across many de­vel­op­ing na­tions, ac­cord­ing to data ear­lier in the month.

“When you have an en­vi­ron­ment where (the) US dol­lar is strength­en­ing and US front-end rates are go­ing up that tight­ens ex­ter­nal fi­nan­cial con­di­tions for emerg­ing mar­kets, es­pe­cially for the deficit economies,” said Mu­rat Ul­gen, global head of emerg­ing mar­kets re­search at HSBC.

Mean­while faced with cap­i­tal out­flows, many emerg­ing mar­ket pol­icy mak­ers have opted to hike rates, thereby also tight­en­ing do­mes­tic fi­nan­cial con­di­tions, Ul­gen added.

“Given that mar­kets have been volatile, gen­er­ally speak­ing, and rates have been higher and eq­uity mar­kets have been lower in sum­mer months... it is highly likely that fi­nan­cial con­di­tions are still stay­ing in the neg­a­tive territory,” he said.

Hav­ing tum­bled some 22 per cent from their Jan­uary peaks, emerg­ing eq­uity mar­kets are in territory com­monly re­garded as a bear mar­ket, is of­ten con­sid­ered to be self-sus­tain­ing de­cline.

“Tighter fi­nan­cial con­di­tions are go­ing to weigh on eco­nomic ac­tiv­ity go­ing for­ward,” pre­dicted Ul­gen.

Emerg­ing mar­kets are fa­mil­iar with such crises.

The In­sti­tute of In­ter­na­tional Fi­nance found nine episodes since 1980 where when real ex­change rates fell 30 per cent or more, the de­val­u­a­tion was sus­tained for at least three years and the de­cline did not re­v­erse a pre­vi­ous over­val­u­a­tion.

Mex­ico suf­fered such a fate in 1995, In­done­sia and Rus­sia in 1998 and Brazil a year later. Mean­while Ar­gentina and Uruguay recorded such de­clines in 2002, Egypt in 2003 and 2016 and Ukraine in 2014.

“There are only 9 episodes his­tor­i­cally where the real ex­change rate has fallen as much and as per­ma­nently,” Robin Brooks, chief econ­o­mist at the IIF wrote in a re­cent pa­per.

“Real GDP falls sharply in the year of de­val­u­a­tion, fol­lowed by a rel­a­tively rapid re­cov­ery. The cur­rent ac­count shifts from size­able deficit to sur­plus in the wake of de­val­u­a­tion, pow­ered ini­tially by im­port com­pres­sion and - over time - ris­ing ex­port vol­umes.”

A weaker cur­rency helps close bal­ance of pay­ments gaps by boost­ing ex­port com­pet­i­tive­ness but also by pinch­ing do­mes­tic pur­chas­ing power while tighter credit saps de­mand and growth.

What’s more, an­a­lysts are also closely as­sess­ing the im­pact of a grow­ing num­ber of trade con­flicts and tar­iffs on emerg­ing economies, which have seen trade be­come an in­creas­ingly im­por­tant fac­tors in gen­er­at­ing eco­nomic ac­tiv­ity.

Ul­gen, who has al­ready chopped his eco­nomic out­look for Turkey, Ar­gentina, Brazil and South Africa, pre­dicts the growth dif­fer­en­tial of emerg­ing ver­sus de­vel­oped mar­ket growth will shrink in the near-term.


Mean­while cap­i­tal flows will play a key role in how the most vul­ner­a­ble economies will weather the lat­est cri­sis. Last year saw healthy flows into emerg­ing mar­kets, ac­cord­ing to HSBC, which es­ti­mates that in 2017 bond mar­kets saw in­flows of $70 bil­lion dol­lars while eq­uity flows were $65 bil­lion.

Fol­low­ing a healthy start to 2018, emerg­ing bond mar­kets have suf­fered a full re­ver­sal of flows; eq­uity mar­kets have seen just un­der half of the $55 bil­lion that had come in un­til the end of May leave again, HSBC found.

Luis Or­ganes at Jpmor­gan warned that a “sud­den stop” or abrupt re­duc­tion in cap­i­tal flows into emerg­ing mar­kets and as­so­ci­ated neg­a­tive feed­back loops should bring an ex­tended pe­riod of ad­just­ment for coun­tries run­ning a large cur­rent ac­count deficit.

“De­spite re­cent EM growth down­grades, ac­tiv­ity data con­tinue to point to down­side risks to our GDP fore­casts,” he wrote in a re­cent note to clients.

“This could be the start of the next phase of a more pro­longed down­turn for EM as­sets given neg­a­tive feed­back loops from EM growth down­grades to fi­nan­cial mar­kets, EM po­si­tion­ing lev­els which have not light­ened mean­ing­fully, and a more en­dur­ing con­ta­gion from Turkey and Ar­gentina.”

Brazil’s cur­rency and main stock in­dex fell on Thurs­day be­cause of mount­ing con­cerns about this year’s elec­tions, with the real un­der­per­form­ing other Latin Amer­i­can cur­ren­cies, which strength­ened on weaker-thanex­pected US in­fla­tion fig­ures.

The real slipped 1.3 per cent, weighed by con­cerns that far­right pres­i­den­tial can­di­date Jair Bol­sonaro, who was stabbed at a cam­paign event last week, may be un­able to cam­paign even in a likely sec­ond-round vote.

Bol­sonaro, who suc­cess­fully un­der­went emer­gency surgery overnight, has tapped a Uni­ver­sity of chicago-trained banker as his main eco­nomic ad­viser. though some in­vestors be­lieved he could gain ground af­ter the in­ci­dent as a re­sult of a sym­pa­thy vote, a re­cent poll showed he would likely lose in the sec­ond round to most of his main ri­vals.

Traders fear a left­ist pres­i­dent would re­frain from cut­ting govern­ment spend­ing to curb debt, which they see as nec­es­sary to bring back Brazil’s in­vest­ment grade sov­er­eign rat­ing. Those con­cerns weighed down the Brazil­ian real on a day when cur­ren­cies of Chile, Mex­ico and Colom­bia all rose more than 0.9 per cent.

The dol­lar fell to a near 1-1/2month low against a group of other ma­jor cur­ren­cies af­ter data showed con­sumer prices in the United States in­creased less than ex­pected in Au­gust, re­duc­ing traders’ ex­pec­ta­tions of ac­cel­er­at­ing U.S. in­fla­tion. Weaker in­fla­tion could drive the Fed­eral Re­serve to hike rates more slowly, bol­ster­ing the de­mand for high-yield­ing, emeg­ing-mar­ket as­sets. Risk ap­petite world­wide was also lifted by signs of re­duced trade ten­sions be­tween China and the United States af­ter Wash­ing­ton reached out to Bei­jing on Wed­nes­day to restart trade talks.

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