Vulnerable Time for Emerging Market Currencies

July 19, 2018

The combination of a tightening Federal Reserve policy, escalating tariff warfare, and heightened geopolitical uncertainty can be particularly risky for the currencies of developing and emerging economies. They tend to be heavily dependent on trade as an engine of economic growth and reliant upon inflows of foreign capital to cover current account deficits. Also, the burden of servicing accumulated debt, much of which is denominated in dollars, will increase if and as the U.S. dollar is lifted by the normalization of short-term U.S. interest rates. A multilateral trade war will drive up the prices of traded goods and, in time, infect inflation rates adversely in many countries. This will dampen economic growth, as will forced interest rate hikes by emerging market central banks to protect their currencies and more generally counter financial market volatility.

Statements released recently by a slew of central banks following policy reviews have in fact flagged the difficulty of conducting policies that preserve price stability whole promoting growth in a world beset by the threat of a trade war, higher energy prices, and other external uncertainties. On Thursday this week, two central banks completed such reviews — the South African Reserve Bank and Bank Indonesia — and communications in each of these cases flagged global uncertainties as a risk that has to be considered.

There already been many examples this year of significant depreciations among emerging market currencies. The Argentine peso has lost about 33% against the dollar since the start of 2018. The Turkish lira has dropped around 16% since end-April. From their February lows, the South African rand has dropped almost 15% and both the Russian ruble and Polish zloty have fallen about 11%. The Brazilian real is over 18% weaker than it was in late January, and the Mexican peso slumped around 14% between April 16 and June 15. Since January 8, the Indian rupee is dropped 7.5%, and the Indonesian rupiah is 8% under its end-2017 level. Even in Singapore, which has a huge current account surplus to GDP ratio, the local currency since late January has declined nearly 5%.

A current account surplus didn’t stop the ruble from losing ground or the offshore Chinese yuan from dropping about 8% since late March. Looking forward, economies with big deficits like Turkey, Argentina, and South Africa may face further tough sledding.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

 

 

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