Dubai: The first week of September saw currency weakness spreading to more emerging market economies, as economic data of some of these countries pointed to further erosion of their currencies.
The recent downward pressure on emerging market currencies began with the currency crises in Turkey, Argentina and South Africa.
In the early stages, sell-off in these currencies were seen as resulting from domestic economic policies and therefore was largely seen as domestic crises that had only limited economic ramifications.
Early trends in September show, as the currency crisis across countries has deepened, it is heading for a contagion, spooking investors in most emerging markets.
The spectacular currency collapses in Turkey and Argentina have put investors across the world on alert for potential currency weaknesses that could hurt their portfolios.
Suddenly everyone who has exposures in emerging markets is taking a closer look at each of these countries’ inflation, external debt and current accounts.
“Typically, high inflation, elevated external debt-to-GDP ratios, current account deficits, and/or political instability are [among others] the hallmarks of a currency on the verge of facing a crisis,” Christopher Vecchio, senior currency strategist at Daily FX wrote in a recent note.
Dollar tantrum
While weak macro data has put their currencies on notice, the emergence of a “mighty” dollar is likely to catalyse the faster downhill rides of many emerging markets.
The latest US employment data released on Friday showed the economy added 191,000 non-farm jobs last month, marking a pickup from the 157,000 increase in July. The unemployment rate is seen edging down to 3.8 per cent, matching an 18-year low.
PMI surveys have also pointed to rising wage costs on the back of labour shortages. Fed rate hike speculation may swell if that translates into pushing the on-year earnings growth rate up from 2.7 per cent, a level it has held since June. As it stands, the priced in probability of a fourth rate hike in 2018 stands at 61.4 per cent, leaving room for an upshift in conviction to boost the US Dollar.
Analysts say economic data is clearly pointing to more trouble for emerging markets currencies in the weeks ahead.
“September has started with a bang with emerging market currencies, commodities and stocks all selling off. More fireworks could be on the way,” said Fawad Razaqzada, market analyst at Forex.com.
Data clearly points what analysts fear the most, an all-out sell off in many emerging markets currencies as the market opens on Monday.
Analysts and economists say there are parallels between the recent rise of dollar, improving US economic data and rising US rates with ‘taper tantrum’ of 2013, when the US Federal Reserve decided to withdraw its monetary stimulus programme that resulted in massive dollar outflows from emerging markets triggering a sell-off in emerging market currencies and asset classes.
Contagion risk
Most developed economies do not have much to fear from the troubles facing Turkey or Argentina, as economic and financial linkages are relatively weak. However, emerging markets are sure to get caught up in the contagion effects. The basic way to avoid the risk of contagion is to run the economy well.
“Large current account deficits, high inflation, excessive external borrowing or over-valued exchange rates create a vulnerability that can be exposed when rising US interest rates create uncertainties over access to funding. This has been the story for many emerging markets crises in the past, where financial markets differentiated relatively efficiently. Most recently, stress was seen with the Taper Tantrum of 2013, when a small group of countries with wide external deficits came under pressure as markets worried about premature Fed tightening,” Bank of Singapore said in a note.
Analysts say among the Asian countries, India, Indonesia and Philippines to a lesser extent run current account deficits. However, the external funding needs, at less than 3 per cent of GDP, seem manageable relative to the size of these countries’ foreign reserves and capacity for policy response.
“Given Asia’s limited financial and trade linkages with Turkey, Turkey should not pose systemic risks for Asia’s growth. We expect the spillover from Turkey’s turmoil on Asian currencies to diminish over time. China/US trade war risk matters more than Turkey to the outlook for Asian currencies,” said Sim Moh Siong, Currency Strategist at Bank of Singapore.
