- Global deleveraging is affecting emerging markets in three ways. First, countries with substantial outstanding net external liabilities have been facing outflows from foreign investors repatriating their assets. Second, in the absence of abundant G10 capital, it will be for current account deficit countries to find funding for their external positions. Third, the higher cost of external funding is posing downside risks to local growth.
- Eastern European economies are among the most exposed to global deleveraging. Asia is the
least exposed, yet there are intra-regional differences, with places such as Korea, India, Indonesia more exposed relative to China, Malaysia and Singapore. - Finally, Latin America lies in between in terms of exposure, with Brazil more exposed relative to Mexico and Chile.
- Dollar strength on a broad basis is contributing to EM FX weakness. This is not just relevant for the Dollar bloc countries. Even Eastern European currencies that are mostly trading relative to the EUR have been hurt by USD strength (as they often trade as high beta proxies for EUR strength). In the near term deleveraging dynamics will sustain the USD at strong levels, which is not positive for EM currencies.
- In the long term, expect fair value dynamics to push the Dollar to weaker levels. Broader USD stability will offer good entry points in currency crosses where value has been created.
- Monetary policy. The tightness in external financial conditions (due to global de-leveraging) increases the downside growth risks for emerging economies. Several emerging markets (such as India and Korea) are choosing to cut rates to promote local growth. The relative shifts in money supply also bring about FX weakness in those places.
- However, other central banks (for example, in Latam) are avoiding cuts as FX volatility could potentially raise the inflation risks for the countries. A more stable environment for local currencies would accommodate monetary easing in these places.
- Overall, there is little scope for substantial strength of EM currencies across the board going forward. In particular, Eastern European currencies are likely to depreciate further and underperform currencies in other regions. That said, some declining FX volatility, a stabilising USD and slowing deleveraging dynamics could allow investors to take advantage of undervaluation benefits.
Emerging market currencies FX Outlook
November 12th, 2008 · No Comments
Tags: EM Market Overview
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