The worst declines since at least 2008 for emerging-market currencies may have further to go as the debt and banking crisis in Europe buffets economies once resistant to the global slowdown.
European lending of $3.4 trillion to developing nations is almost triple that from U.S. and Japanese institutions combined, according to Bank for International Settlements data through March 2011. This leaves emerging countries more vulnerable to Europe’s sovereign debt crisis than they were to the global credit meltdown in 2008, according to Royal Bank of Canada.
The International Monetary Fund reduced growth projections for emerging markets last month, as the deepening European crisis stifles liquidity and threatens to drive the global economy into recession. Option traders are increasingly bearish on currencies including the Brazilian real and South African rand, according to data compiled by Bloomberg.
“The problems are centered in western Europe and the U.S. so those asset prices moved first and it’s now trickling down to emerging markets,” Nick Chamie, the global head of emerging market research at Royal Bank of Canada’s RBC Capital Markets unit in Toronto, said by telephone Sept. 27. “Until conditions stabilize in a long-lasting way in Europe and the U.S. in terms of the economic outlook, emerging market assets will continue to come under selling pressure.”
Investors pulled $3.2 billion out of emerging-market debt funds in the week ended Sept. 28, the biggest outflow since 2005, according a report by ING Groep NV on Sept. 29, citing data compiled by EPFR Global Data. The withdrawal accounted for 2.3 percent of total assets.
Brazil’s real, Hungary’s forint, Poland’s zloty and other developing-country currencies declined more than 12 percent on average last month against the dollar. An index of six Latin American exchange rates fell 11 percent, wiping out all the gains in the past two years, and major Asian currencies slid 4.2 percent, the most since the region’s financial crisis in 1997, according to data compiled by Bloomberg and JPMorgan Chase & Co.
“The selloff has more to go,” Bhanu Baweja, global head of emerging-market currency and credit strategy at UBS AG in London, said in a telephone interview Sept. 27. “Decoupling doesn’t happen when the developed world is in bad shape.”
Instead of raising interest rates, central banks in Brazil and Turkey have cut borrowing costs to bolster economic growth as exports slow, reducing the allure of their currencies. Policy makers from Chile to Mexico have signaled that they are ready to follow should the global economy weaken further.
Developed countries accounted for 52 percent of gross domestic product, with the 17-nation euro region and the U.S. making up 34 percent, IMF data show.
Citing “severe” repercussions if Europe fails to contain its debt crisis or U.S. policy makers deadlock over a fiscal plan, the agency said in a Sept. 20 report that growth in emerging countries will total 6.4 percent this year and 6.1 percent in 2012. Those projections are down from 6.6 percent and 6.4 percent it forecast earlier.
Emerging markets “will not be completely immune to the slowing in developed market activity,” JPMorgan economists wrote in an Oct. 5 report. The New York-based firm cut its annualized global growth estimate for the next three quarters by almost 1 percentage point to 1.7 percent.
Credit Suisse Group AG reduced growth forecasts for developing economies to 6 percent this year and 5.6 percent next year from an expected 6.2 percent expansion in 2011 and 6.1 percent in 2012. London-based analyst Kasper Bartholdy cited “calamity risk in Europe” as a risk to the outlook, in a note to clients today.
The $3.4 trillion in lending to emerging markets from banks in Europe, including Germany and the U.K., compares with $299 billion from Japan and $727 billion from the U.S., according to BIS data as compiled by Royal Bank of Canada.
European banks’ lending to Hungary amounted to more than 70 percent of that country’s GDP, according to estimates by Barclays Capital based on BIS data. Lending to Poland reached 40 percent of GDP, and that to Brazil and Mexico was equal to about 20 percent of their economies.
Lenders are already cutting back. London-based HSBC Holdings Plc was the No. 6 arranger of syndicated loans in the Asia-Pacific region outside Japan last quarter, down from No. 4 a year earlier, Bloomberg data show. Montrouge, France-based Credit Agricole SA dropped to 21 from 17, while Royal Bank of Scotland Group Plc, which sold assets in Asia after receiving the biggest bailout in banking history from the British government during the financial crisis, fell to 25 from 19.
The IMF’s forecast that emerging-market economies will expand 6.4 percent this year is still four times greater than the 1.6 percent rate for developed nations.
They are also on sounder fiscal footing. Emerging-market sovereign debt will probably amount to 35 percent of GDP this year on average, about one-third the level for developed markets, the IMF said in June.
Trading patterns show the currencies may be poised to rally. The 14-day relative strength index for Russia’s ruble versus the dollar remained below the 30 level for 19 days, through Oct. 5, the most since 2009. A reading lower than 30 signals an asset’s price may have fallen too quickly and may rebound. The South Korean won measure was under 30 for 13 days, the longest run since 2008.
After trying to keep their currencies from appreciating too quickly and hurting exporters, central banks in countries such as Turkey, Russia, and Brazil are acting to stem declines.
Turkey’s central bank sold a record $750 million for lira in an auction Oct. 5, propping up the nation’s currency from an all time low. Russia’s sold about $8 billion to shore up the domestic currency last month. That’s the most since it stopped the ruble’s fall in January 2009, central bank chairman Sergey Ignatiev said.
The ruble strengthened for a third day today, gaining 0.1 percent to 32.3443 per dollar at 2:31 p.m. in New York. The Russian currency has been rebounding from its weakest in more than two years of 32.9, reached on Oct. 4. Turkey’s lira was little changed at 1.8483 per dollar after surging 2.4 percent in the previous three sessions.
After 28 months trying to limit gains in the real, Brazil’s central bank used derivatives on Sept. 22 to support the currency after it fell to a two-year low. Just a year earlier, Brazil Finance Minister Guido Mantega accused the U.S., Japan and Europe of sparking a global “currency war” and said the U.S. was “melting” down the dollar by flooding the economy with greenbacks.
“The intervention is an attempt to control the speed but they cannot draw a line in the sand,” Stephen Jen, the managing partner at SLJ Macro Partners LLP in London and a former currency strategist at Morgan Stanley, said in a telephone interview Oct. 5. “The emerging market currencies have more downside risk.”
Traders paid 11 percentage points more for the right to sell the real in three months than to buy, the most since January 2009, according to so-called risk reversal rates compiled by Bloomberg. The premium to insure against further drop in the rand rose to 8.2 percentage points, the most since March 2009.
The recent selloff is a reversal from much of the past two years, as investors sought emerging-market assets to avoid record-low interest rates in the developed world. Rising demand pushed the average yield on emerging market sovereign dollar-denominated debt down 51 basis points, or 0.51 percentage point, this year to 2011’s low of 6.12 percent on Aug. 3, according to JPMorgan index data.
Twelve emerging market currencies rallied more than five percent against the U.S. currency during that time.
“Over the last two years emerging markets have benefited across the board, even those that are undeserving, as a rising tide floats all boats,” Michael Woolfolk, a senior currency strategist in New York at Bank of New York Mellon Corp., said in a telephone interview Sept. 30.
The yield on the JPMorgan index rose to 6.5 percent yesterday as investors began to trim their bullish bets.
Emerging-nation equity funds have posted nine straight weeks of outflows, losing $21 billion, according to research firm EPFR Global. The Standard & Poor’s Asia 50 Index tumbled 10.9 percent and Brazil’s Bovespa Index sank 7.4 percent in September. The Mexican IPC index fell 6.2 percent last month, contributing almost half of the 14.4 percent year-to-date losses.
The dollar rose against all emerging-market counterparts except for the Hong Kong dollar in September, its best month since May. The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against the currencies of six major U.S. trading partners, rose 6.3 percent, beating the MSCI All-Country World Index of stocks, Bank of America Merrill Lynch’s Global Broad Market Index of bonds and S&P’s GSCI Total Return Index of 24 commodities.
“The loosening policy by central banks will continue further down the road,” Kathryn Rooney Vera, an analyst at Bulltick Capital Markets in Miami and a former emerging-market economist at Bear Stearns Cos., said in a telephone interview Sept. 30. “There’s no substitute to the U.S. dollar at this point as a safe haven and the reserve currency.”