The strong dollar has beaten down emerging markets currencies ahead of prospective Federal Reserve rate increases, but the fallout for developing economies will vary widely.
Weak EM currencies could be positive for exports and future economic growth in many cases, analysts say. However, there are concerns about potential capital flight and localized emerging markets debt crises.
“For most emerging markets, dollar debts are more manageable than in the past, while a weaker currency will help to boost competitiveness and narrow current-account deficits,” says Neil Shearing, chief emerging markets economist at London-based Capital Economics. “Even in countries with large dollar debts (notably Turkey and Brazil), a weaker currency is a prerequisite to putting the balance of payments on a more stable footing.”
J.P. Morgan’s Emerging Markets Currency Index tumbled to a record low in March, following strong US jobs data. Christine Lagarde, head of the International Monetary Fund, warned that there could be a repeat of the 2013 “taper tantrum” when US rates begin to rise. She said: “The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility.”
Some emerging markets countries do not want such weak currencies, says Marc Chandler, global head of markets strategy at Brown Brothers Harriman. Mexico, for example, has recently said as much, and has taken some steps to slow the peso’s descent.
“I don’t think there will be a [currency] crisis like in 1997‒1998, as there are no [or few] fixed-exchange regimes to bust,” Chandler says. “Many emerging market countries have amassed large holdings of reserves. Some have made some structural reforms.”
If there is a currency crisis, it may be limited to countries that have serious political problems as well, such as Brazil or Turkey, according to Chandler. In Turkey, which has high inflation, the government has been pressuring the central bank to lower rates. In Brazil, the Petrobras corruption scandal is threatening the ability of the government to implement its austerity program.
The overall level of emerging markets risk, as measured by the Capital Economics Risk Indicator (CERI), remained at a 10-year low in March, but the firm cited concerns about a handful of countries. Venezuela already appears to be suffering an economic crisis, Capital Economics says, while the CERI score has begun to edge up again in both China and Turkey.
Deteriorating trade balances also continue to be a key source of risk for emerging markets, Capital Economics adds. It cites strains in the balance of payments for such countries as Peru, South Africa and Indonesia. While all emerging markets currencies have fallen against the dollar since the middle of 2014, in some countries (particularly in Asia), the depreciation has been modest, Shearing says. “Strong ties to the US mean that exporters in Mexico stand to benefit the most,” he adds. “But so, too, do many Asian economies.”
Indonesia’s central bank governor Agus Martowardojo said in March that he wasn’t concerned about the weakening of the rupiah. He said it would help boost manufactured exports at a time when commodity prices are depressed.