Each miserable in its own way: behind the routs in SA and other vulnerable markets
The tempest blowing through emerging markets has its origins in several smaller storms as easy money dried up
London/New York — This year’s global emerging-market sell-off has its roots in a slew of mini-routs as the era of easy money came to an end.
Consider Turkey, now paying the price for its refusal to follow orthodox monetary policy; Argentina, facing a crisis of confidence just four years since its last default; China, targeted in a trade war; and SA, the emerging-market proxy punished for crisis in any corner of the asset class.
Here is a look at what is actually behind declines in markets most vulnerable in the current geopolitical and monetary environment.
South America’s number two economy has a benchmark interest rate of 60% and inflation tops 31%. The real policy rate now ranks among the world’s highest and is pushing the economy back into recession. Economic activity fell 6.7% in June. New taxes announced this week to restore a balanced budget would only compound the suffering.
Argentina is targeting a primary budget surplus by 2020 to ease its demand for foreign financing and prop up the peso, which slumped more than 50% this year.
Whether those economically sound and highly unpopular policies can survive the next few years remain to be seen: national elections are scheduled for just 13 months from now.
Brazil’s key weakness lies in fiscal shortfalls thanks to anaemic economic growth.
While the public sector’s primary budget balance, a measure of fiscal health before interest payments, now stands at a 1.1% deficit of gross domestic product compared with 3% at the worst point of 2016, it still compares unfavourably with an average 2.9% surplus between 2000 and 2014.
Further complicating things is October’s wide-open presidential election. Its proximity and close trade links to Argentina mean contagion could also weigh on sentiment.
All that said, a historically low policy rate means Brazil has plenty of room to tighten monetary policy and fend off speculative attacks on the real, the third-worst emerging-market currency this year.
Donald Trump’s trade war couldn’t have been more poorly timed for the world’s second-largest economy.
China’s current account surplus has plunged to near zero and is threatening to tip into a deficit. The yuan’s real effective exchange rate against a basket of trading partners is hovering near a record high, signalling the currency may have room to depreciate.
The twin pressures pose a challenge to China’s efforts to keep yuan volatility to a minimum and may also undermine a core economic objective: gaining an enhanced role for the yuan as a means of international payments. The currency’s share in global transactions has fallen to just 1.8% from 2.8% three years ago.
Shanghai stocks have underperformed emerging-market peers in 10 of the past 12 quarters and trade near the lowest valuations in four years.
Annual expansion above 7% and a relative isolation from global economic and trade headwinds make India a consensus buy among emerging-market investors.
Oil remains the chief vulnerability: India imports 70% of its energy needs and crude-price fluctuations have taken its current-account deficit to almost 2% of GDP.
Prime Minister Narendra Modi is seeking re-election in just eight months and victories for the opposition Congress party in recent state and local elections have raised the possibility his support may be slipping. Even though India’s major parties all agree on the direction of economic reform, a hung parliament could result in policy paralysis.
While the rupiah lost about 9% this year, a pittance compared with Turkey and Argentina, the Indonesian currency is now the weakest since the 1998 Asian financial crisis. Repeated rate hikes and forex interventions by Bank Indonesia have failed to stem the depreciation.
While monetary tightening, as well as the delay of major investment projects to save foreign-exchange reserves will slow growth, the risk of outright recession is less than in many other countries because the economy has expanded at a clip of about 5% since 2014. Subdued inflation may also alleviate concern of the price pass-through of a weaker currency.
Russian assets get some of the lowest valuations in emerging markets because of investor perceptions that private wealth isn’t protected enough.
While the country has rebounded from a currency crisis in 2014, it remains one of the first targets in an emerging-market sell-off. A key vulnerability: a US climate in which being seen as pro-Russia is politically disadvantageous. Criticism by Democrats has pushed President Donald Trump to add to existing sanctions.
Russia has a strong current-account surplus and inflation is near a record low. That helped the central bank cut interest rates. But policymakers are signalling an end to the easing cycle as price pressures build, laying the groundwork for Russia’s first increase in borrowing costs since 2014. The ruble was the fourth worst performer against the dollar last month.
Africa’s most industrialised economy is already in recession, driven by a slump in agricultural output. South Africa has one of the worst current accounts deficit in the developing world, with a shortfall of 4.8% of GDP. Optimism over President Cyril Ramaphosa’s economic plan has waned, while a worsening trade war, or a slowdown in China, may push the commodity-dependent economy further downhill.
South Africa’s main weakness is excess liquidity, according to Charles Robertson, the London-based global chief economist at Renaissance Capital. South Africa has the highest ratio of foreign-exchange turnover to GDP among emerging markets, he said, helping explain why South Africa is often at the forefront of developing-world routs.
Events during the past several months underscore the grave political risks facing investors in the Turkish market.
The appointment of a new cabinet, in which President Recep Tayyip Erdogan’s son-in-law took over economic affairs, the leader’s own opposition to rate hikes, and the diplomatic spat over a detained US pastor have all dented confidence, prompting a 31% collapse in the lira since the end of June, the most among emerging-market currencies.
In addition, Turkey is coping with double-digit inflation and the biggest current-account deficit among major emerging economies.
Currency depreciation may be sorely needed to help drastically cut imports and trim the current account gap.