Although investors became a bit disillusioned with emerging economies after the Mexican peso's crash in late 1994, the huge profit opportunities offered by such markets have inevitably attracted fresh flows of investment funds. Yet as Nariman Behravesh of DRI/McGraw-Hill observes, the risks of investing in emerging markets haven't disappeared. "Poor economic policies or political instability," he says, "can still precipitate a sudden currency decline."
Where is the next currency crisis likely to occur? To assess the risks, DRI weighs such possible danger signals as large current-account deficits, low savings rates and foreign exchange reserves, and capital inflows skewed toward portfolio rather than direct investments. It also assesses such political woes as wars and domestic unrest.
According to DRI's Global Risk Service, Brazil currently heads its list of nations that could suffer a sizable currency depreciation over the next year. Others high on the list include Taiwan, Turkey, Malaysia, and India (chart).
Economic factors threaten Brazil's and Malaysia's currencies. Brazil's exploding budget deficit has forced the central bank to jack up interest rates to quell inflation, leading to an overvalued currency and trade imbalance. Malaysia's boom, along with shortages of skilled labor and infrastructure bottlenecks, has imports surging. With its currentaccount deficit nearing 10% of gross domestic product, investors are jittery.
By contrast, Taiwan's currency vulnerability is largely due to a political factor: its tense relations with China. In Turkey, which suffered a huge devaluation in early 1994, a recently elected, shaky coalition government may be unable to implement austerity measures needed to curb government spending and temper a chronic, 80% inflation rate. And India's currency is being buffeted by uncertainty over upcoming elections, a major political scandal, a worsening budget deficit, and rising inflation.
Although the chances of a big near-term currency decline in any specific nation on this list is no higher than about one in three, Behravesh notes that the likelihood that at least one will suffer such a crisis is well over 50%. Thus, "companies investing in emerging economies would be wise to take steps to hedge against devaluation in countries where their exposure is large."