Contagion spreads in emerging markets as currency crises grow

Worst sell-off in five years begins to reveal extent of fallout from Fed’s tapering of stimulus, compounded by financial and political instability

Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signalled it would scale back stimulus.
Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signalled it would scale back stimulus.

New York: The worst sell-off in emerging-market currencies in five years is beginning to reveal the extent of the fallout from the US Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability.

The Turkish lira plunged to a record and South Africa’s rand fell on Thursday to a level weaker than 11 per dollar for the first time since 2008. Argentine policymakers devalued the peso by reducing support in the foreign-exchange market, allowing the currency to drop the most in 12 years to an unprecedented low.

Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signalled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.

“The current environment is potentially very toxic for emerging markets,” Eamon Aghdasi, a strategist at Societe Generale SA in New York, said in a phone interview on Thursday. “You have two very troubling things: uncertainty about the Fed policy, combined with concerns about growth, particularly in China. It’s difficult to justify that it’s time to go out and buy emerging markets at the moment.”

Developing-nation currencies sold off after a report from HSBC Holdings Plc and Markit Economics indicated on Thursday that China’s manufacturing may contract for the first time in six months, adding to concern that growth is losing momentum.

The declines were part of a broader slide in global markets on Saturday, with European stocks falling, US stock futures lower and Asian shares tumbling. Yields on 10-year German bunds slipped to an 11-week low, while the yen, considered by investors as a haven, rose versus all 16 major counterparts tracked by Bloomberg.

Currencies of commodity-exporting countries that depend on Chinese demand sank, with the rand plunging 0.9%, following Thursday’s 1.1% decline. Brazil’s real fell 0.4% while Chile’s peso climbed 0.2% after decreasing 1.2% on Thursday.

Argentina’s peso fell 12% on Thursday to 7.8825 per US dollar, marking its biggest decline since a devaluation in 2002. The central bank pared dollar sales aimed at propping up the peso to preserve international reserves that have fallen to a seven-year low. On Friday, the central bank said it would lift two-year-old currency controls and allow the purchase of dollars for savings starting next week. The peso traded at around 13 per dollar in the black market on Thursday.

In Venezuela, the government devalued its currency for airline tickets and incoming foreign direct investment on 22 January. International reserves are at a 10-year low.

The Turkish central bank’s first unscheduled intervention in more than two years wasn’t enough to stop the lira from setting a record low today. Investors are speculating the central bank’s efforts to prop up the lira by burning through foreign-exchange reserves will prove futile without raising interest rates.

The lira plunged to a record 2.3224 per dollar and also declined to an all-time intraday low of 3.2069 per euro. Turkey’s central bank refrained from raising benchmark rates this week, fueling concern that it will be difficult to finance current-account deficits.

Turkey holds about $33 billion in foreign reserves, excluding deposits from commercial banks, only enough to cover 1 1/2 months of imports, according to Citigroup Inc.

“It’s a bad storm,” Neil Azous, the founder of Rareview Macro LLC, a Stamford, Connecticut-based advisory and research firm, said in a phone interview on Thursday. “Their net foreign- exchange reserves are dwindling pretty fast. They’re definitely in the danger zone. If you’re a money manager, the responsible action is to take some measures to reduce risk.”

The International Monetary Fund predicts that the growth advantage of emerging markets over advanced economies will shrink this year to the smallest since 2001. The Washington-based group kept its expansion forecast for developing countries this year at 5.1% on 21 January, while raising the outlook for advanced economies to 2.2%, from the 2% estimated in October.

China is struggling to contain $4.8 trillion in shadow- banking debt, raising concern about the growth outlook for a country that buys everything from Chile’s copper to Brazil’s iron ore. A corruption investigation is embroiling Turkish Prime Minister Recep Tayyip Erdogan’s cabinet, while deadly protests in Ukraine and Thailand are eroding confidence in the political stability of developing nations.

The gradual erosion of sentiment for the EMs, owing to the perception that several EM economies or countries are “on the brink”, simply made the run on reserves in Argentina and the poor China data the “straws that broke the camel’s back”, Thierry Albert Wizman, a strategist at Macquarie Group Ltd in New York, wrote in an email to clients on Thursday.

A Bloomberg customized gauge tracking 20 emerging-market currencies fell to 89.82 on Friday, the lowest level since April 2009. The index has tumbled 10% over the past 12 months, bigger than any annual decline since it slid 15% in 2008.

Ukraine’s hryvnia slumped as Parliament planned to hold an emergency session after anti-government protests led to fatalities this week. The currency fell as low as 8.48 per dollar, the weakest since 2009, before retracing losses to 8.375 per dollar, little changed over the past two days.

South Africa’s rand tumbled as much as 1.8% to 11.1949 per dollar on Friday on concern a strike at the world’s biggest platinum mines would dent the country’s exports.

The sell-off in emerging-market currencies started in May, when the Fed signalled it may pare the monthly asset purchases that had helped fuel investment in developing nations. Yields on US Treasuries rose in response.

“In an environment of rising US rates, the market is quickly finding out who has been swimming naked,” Dirk Willer, a Latin America strategist at Citigroup, the second largest currency trader, wrote in a client note. He said it’s not unreasonable for the Argentine peso to fall to 14 per dollar.

The recent weakness has created buying opportunities for some emerging markets with stronger economic prospects, according to Marcela Meirelles, a Latin America sovereign strategist at TCW Group Inc.

This sell-off will create eventually good buying opportunities of those EM credits with strong fundamentals and there is still no shortage of them around the world, Meirelles said in an emailed reply to questions.

HSBC recommends clients buy the Mexican peso against the Chilean peso, saying Mexico’s currency will benefit from expansion in the US as efforts to open up the energy industry to outside investment boost its southern neighbour’s long-term growth potential.

While differentiation is important, the end of China’s investment and export boom may still put emerging-market currencies on a declining trend, according to Morgan Stanley.

“We continue to see the risks surrounding China’s macro trajectory as having a negative impact on EM,” Rashique Rahman, the New York-based co-head of foreign-exchange and emerging-market strategy at Morgan Stanley, wrote in a note on Thursday. “As capital costs rise and investment slows, commodity prices should come under pressure, boding poorly for economies linked to China’s old growth model.”

Morgan Stanley has a reduce rating on emerging-market currencies, while recommending selling the Russian ruble against the dollar.

Brazil’s real fell to a five-month low of 2.4327 per dollar on Friday and has lost 28% over the past two years. Brazil should return to the policies of former President Luiz Inacio Lula da Silva to boost growth, tame rising consumer prices and attract foreign investment, Pacific Investment Management Co. said on Thursday.

“Valuations are attractive, but unless an effective policy mix is restored, the outlook for order in Brazil’s financial markets is less certain,” Michael Gomez, the co-head of emerging markets, said in a report published on the fund’s website on Thursday.

Pimco chief investment officer Bill Gross said last week that Brazil was no longer a preferred market. The comment came more than a decade after the firm bought the country’s bonds as they plunged before presidential elections in 2002, a bet that proved prescient.

“The market is punishing those countries with bad policies and politics,” Bhanu Baweja, the head of emerging-market cross-asset strategy at UBS AG, said by phone from London. “There isn’t panic, but we are not finished yet. There’s no reason to buy emerging for now.” Bloomberg

Andrea Jaramillo in Bogota, Andrea Wong, Katia Porzecanski and Nikolaj Gammeltoft in New York and Paul Armstrong in London contributed to this story.

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