Fragile Five Swoon Anew as Iraq-Oil Link Gives PauseYe Xie and John Detrixhe
After months spent working to erase their image as emerging markets to avoid, the Iraq crisis and its influence on oil prices are putting the fragile five currencies back on investors’ sell lists.
Indonesia’s rupiah, South Africa’s rand, the Indian rupee and Turkey’s lira are the four worst performers of the 31 major currencies tracked by Bloomberg over the past month, while the Brazilian real is little changed after three months of gains. Societe Generale SA and BNP Paribas SA recommend selling the lira, while Citigroup Inc. identifies the rupee and rupiah as the riskiest Asian currencies.
“We’re growing concerned about the situation in Iraq, which has the potential of undermining the performance of EM assets,” Benoit Anne, the head of emerging-market strategy at SocGen in London, said in a June 19 report. Oil “has become the main risk indicator for emerging markets.”
Morgan Stanley coined the term “fragile five” in August 2013 to describe currencies that are particularly vulnerable because of their dependence on foreign investment to fund current-account deficits. With most of their trade shortfalls made up of oil imports, the surge in Brent crude to a nine-month high would tend to affect these countries more than others and is causing the value of their exchange rates to tumble.
A Morgan Stanley analyst couldn’t be reached for comment on those currencies.
Oil prices have been climbing since early June as an al-Qaeda breakaway group known as the Islamic State in Iraq and the Levant seizes territory across Iraq, threatening to disrupt the supply of the second-largest producer in the Organization of the Petroleum Exporting Countries. South Africa, Turkey and India import 70 percent or more of their oil needs.
The crude oil rally has been tempered the past two days as Iraqi forces regained control of the Baiji refinery in the north from Islamist militants, and fighting hasn’t spread to the south, home to more than three-quarters of the country’s crude output.
U.S. Secretary of State John Kerry visited Baghdad this week to try to get political leaders to set aside sectarian divisions and confront the crisis, which he warned could engulf neighboring states including Jordan. Brent oil prices jumped to $115.71 a barrel on June 19, the highest since Sept. 9.
“Risks are higher for the fragile five, either through trade, inflation and fiscal links, or through a sentiment link,” Ju Wang, a Hong Kong-based currency strategist at HSBC Holdings Plc, said yesterday in an interview. “We did see the rupee and rupiah underperforming in a high oil environment. Both are likely to suffer from higher oil-import bills and increased inflation pressure. The lira probably also suffers from high commodity-import costs, but also is close to the Iraq turmoil.”
The rupiah led declines among major currencies in the past month, tumbling 3.2 percent and reaching a four-month low of 12,027 per dollar on June 18. Indonesia subsidizes fuel costs and higher oil prices may worsen the nation’s budget shortfall and current-account deficit. Malaysia is the only net exporter of crude in Southeast Asia, helping support the ringgit.
Brazil’s real has benefited from central-bank intervention and gained 0.2 percent in the past month, while the rand, rupee and lira fell from 2.6 to 2.8 percent. SocGen predicts Turkey’s currency will drop to 2.24 per dollar in the next three weeks, from 2.1298 today.
Circumstances were different earlier in the year. Emerging-market currencies suffered their worst January since 2009 as the U.S. Federal Reserve started tapering its stimulus program and new evidence emerged of a slowdown in China, which is the world’s biggest importer of iron ore, copper, soybeans, cotton and natural rubber.
That spurred nations from Brazil to South Africa to bolster their fiscal health with measures from interest-rate increases to import tariffs. As a result, their currencies were among the top seven developing-nation performers versus the dollar from January through May.
Record-low volatility will boost demand for currencies in nations with high interest rates, according to Viktor Szabo, a money manager at Aberdeen Asset Management Plc, which manages $541 billion. He said he’s maintaining bullish bets on the rupee and rupiah because of their high rates.
“Global liquidity will remain quite supportive,” London-based Szabo said by phone on June 19. “It’s a supportive carry-trade environment.”
To Stephen Jen, the co-founder of London-based SLJ Macro Partners LLP and a former International Monetary Fund economist, the recent losses show those nations’ measures to improve fiscal health weren’t enough.
“These countries have not done enough to meaningfully alter their structural savings positions,” Jen said yesterday by e-mail. “All that’s been done in many of these countries is higher real interest rates that have hurt demand. The outperformance of these currencies since February reflected more the factors on the dollar side,” including Fed signals it will put off normalizing U.S. interest rates, he said.
The nations did succeed in reducing the deficits in their current accounts, the broadest measure of trade.
While Turkey’s narrowed to 7.5 percent of gross domestic product in the first quarter, from 8 percent at the end of 2013, it’s still one of the highest among emerging markets in Europe and Africa monitored by Bloomberg. India’s deficit was 1.9 percent and South Africa’s was 4.5 percent of GDP.
The currencies may be vulnerable amid investors’ suspicion that countries including India and Turkey are done raising rates, according to Kieran Curtis, an emerging-market debt manager at Standard Life Investments Ltd. in London, which oversees $271 billion.
“The currencies don’t seem to have the same momentum behind them,” Curtis said by phone on June 20. “This oil story is a headline risk for the oil importers. We are getting more cautious.”