The most vulnerable emerging market to higher rates
Emerging markets are in better positions now than they were in 2008 to withstand external shocks. But some of them are still vulnerable, research finds
Back in 2008, emerging markets coped with the effects of the global financial crisis without "structural damage," although a small number of countries received liquidity support from the International Monetary Fund (IMF), according to Markus Jaeger, emerging markets analyst at Deutsche Bank.
They adjusted to shocks to their capital and current accounts by currency depreciation, liquidity support from their central banks and by the contraction of their economies.
Judging by the external financing requirements (EFR) which show the ratio of short-term debt, medium-and long-term debt amortizations and the current account in relation to foreign exchange reserves South Korea, Poland and South Africa have much stronger positions now compared to 2008, while India and Indonesia have "slightly weaker, but still solid, positions," Jaeger wrote in a note.
Generally, EFR below 100% mean the country is able to withstand external shocks while those above show vulnerability.
"Only Turkey's EFR are today both higher than in 2008 and above the 100% threshold," Jaeger noted.
Earlier on Monday, Moody's warned Turkey that risks were increasing for its balance of payments because of uncertainty created by the continuation of protests that started nearly two weeks ago.
South Africa's EFR are a little above 100% nowadays compared to 150% in 2008. Poland, which had EFR above 150% in 2008, is currently below 100%.
China, Brazil, Russia and South Korea are in the best positions, with EFR below 50%, according to data by the Institute of International Finance (IIF) and Deutsche Bank Research.
Jaeger points out that with capital accounts of the major emerging markets "relatively open" and foreign investors holding "significant amounts" of local currency-denominated debt and equity, potential pressure on the balance of payments "can far exceed EFR."
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"However, it is clear that non-resident local currency and especially equity claims will weigh far less on the balance of payments than short-term foreign currency-denominated debt claims," he said.
Overall, emerging markets are more solid currently than they were five years ago, as many have put in place regulations that limit the extent to which banks can run foreign currency risks, according to Jaeger.
Emerging market currencies fell sharply on Monday, with investors spooked by statements from Federal Reserve Chairman Ben Bernanke last month signaling the end of the central bank's policy of printing money.
The fall was led by the South African rand (ZAR) but the Turkish lira (TRY), the Indian rupee (INR), the Hungarian forint (HUF) and Brazilian real (BRL) also weakened sharply.
John Higgins, Chief Markets Economist at Capital Economics said that besides the renewed worries about the Fed's tapering of quantitative easing, some emerging market currencies were hit by local factors such as political instability and interest rate cuts, and by falls in commodity prices for commodity-producing countries.
"We think these factors will weigh further on many emerging market currencies in the second half of this year," Higgins said.
"For a start, although we dont expect interest rates to be raised until mid-2015 at the earliest, the Fed could start tapering its asset purchases as early as September this year, which investors may view as the tip of the iceberg for monetary tightening."
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