Like choker necklaces, vinyl, and carrot cakes, emerging market concerns are making a comeback this year. What’s up with that?!
Emerging markets (EM) refer to relatively small economies seeing increasingly open markets. And because they tend to see faster growth than the developed economies, they usually attract risk-loving investors.
Now, unless you were too busy crying over Miley and Liam’s breakup back in 2013, then you’ll remember that EMs lost some of their shine when a combination of political instability, China’s “hard landing” jitters, and tighter Fed policies put pressure on a lot of EMs.
Do the themes sound familiar to you? They should! Thanks to major central banks tightening their monetary policies and a cocktail of other factors, investors are now back to worrying about the emerging markets.
Economic troubles aren’t confined to groups with catchy names such as the “Fragile Five” anymore, so I’ll just list down the factors that can put pressure on the emerging markets (and their currencies):
Ability to pay debt
With great growth comes great debt. Emerging-market borrowing jumped from 145% of GDP in 2007 to 210% of GDP in 2017.
Bloomberg estimates that EM borrowers would need around $1.5 trillion in both 2019 and 2020 to repay or refinance their debts. Thing is, not a lot of them can cover these expenses.Turkey and Argentina, for example, can’t cover their immediate foreign-currency obligations without borrowing more money. In fact, Argentina’s President Mauricio Macri just imposed new export taxes and spending cuts in a bid to secure a loan from the IMF. Unfortunately, ARS traders weren’t impressed.
If that’s not depressing enough, major central banks like the Fed are also raising their rates and pulling investors back to dollar-denominated assets and the like.
This drains liquidity in the global markets and makes it more expensive for EMs to borrow more moolah. Yipes!
Monetary and fiscal policies can either help or exacerbate market imbalances in the economy.
Higher interest rates, for example, could stifle growth and inflate prices unnecessarily. Higher government spending – allocated to unproductive programs – could put pressure on the country’s finances.
Last but not the least, corruption, political instability, and conflicts with major trading partners would sow uncertainty and drive yield-seekers away.
This week, political instability in Brazil has dragged the real to its two-year lows. India’s central bank also had to resort to currency intervention after the rupiah saw sharp depreciation last week. Meanwhile, failure to control inflation and the government’s conflict with the U.S. helped drag the lira to fresh record lows last month.
Attractiveness of traditional assets
We’ve already talked about how tightening in major economies are draining liquidity for the emerging markets and making it more expensive for them to acquire new capital.
Like in 2013, geopolitical risks (and now global trade tensions) are also making it easier for investors to drop their “riskier” investments in favor of their dollar/euro/yen-denominated ventures.
And then there’s teeny-tiny issue of currency strength. Stronger funding currencies automatically makes emerging market debts more expensive.
Not only that, but dramatically weaker currencies for emerging markets can also aggravate economic imbalances (like having twin deficits) that hinder further growth.
How can I trade these info?
Unless we see some serious gamechangers, it’s likely that we’ll see more investors dump their riskier bets in favor of assets in more developed economies.
If you’re planning on buying exotic currencies like the real, lira, or the rupiah, then you should at least watch the newswires closely for headlines related to the points above for clues on how the currencies will react.
Just keep in mind that trading exotic currencies usually means wider spreads and more volatility. Make sure you’re watching your trades closely when you have open trades!