CaixaBank: Focus on Fragile Emerging Economies

Caixa Bank Research’s latest report on the international economy provided insight on the fragility of emerging markets. On June 14th, 2018, the Argentine Peso and the Brazilian Real lead the weakness in emerging market currencies falling 6.1 percent and 2.2 percent on the day. A down day that comes just a day after the Federal Reserve raises rates and reaffirms its hawkishness through the rest of the year.

Emerging market currencies have not just had a weak past 24 hours. Since the beginning of May, Caixa reports that “the Argentine peso has depreciated nearly 20% against the US dollar, the Turkish lira more than 10%, and a large number of currencies (including the Polish zloty, the Brazilian real, the Mexican peso, the Chilean peso and the Colombian peso) have depreciated by between –6% and –4%.” The numbers are quite staggering and suggest the hawkish trend in U.S. interest rates is viewed as a crisis-level threat to the stability of emerging markets’ financial systems. Caixa describes them as “fragile” and points to Argentina and Turkey as the prime examples.

Both Argentina and Turkey have similar “macroeconomic imbalances” which include high inflation and a current account deficit. More specifically, Argentina and Turkey reported 26.5 percent and 10.8 percent inflation in April and a 4.6 percent and a 5.6 percent current account deficit at the end of 2017, respectively. While the macroeconomic maladies are dangerous, the inability to implement efficient fiscal and monetary policy leaves it vulnerable to shocks that can lead to crises.
The point of Caixa’s article is to compare the current state of the “fragile” emerging economies to the state of emerging economies in 2007 when “the emerging countries were at the end of the previous cycle of growth.” The report compares nine different macroeconomic indicators comparing 2007 emerging economies to today’s emerging economies:

  • Current account balance (% GDP) has decreased suggesting a reduction in financial vulnerability.
  • External debt (% GDP) has grown significantly suggesting a worsening in financial vulnerability.
  • Short-term external debt (% GDP) increased significantly suggesting a worsening in financial vulnerability.
  • Inflation is down slightly suggesting a reduction in financial vulnerability.
  • Credit-to-GDP gap is has increased suggesting a worsening in financial vulnerability.
  • Currency to short-term external debt ratio has decreased slightly suggesting a worsening in financial vulnerability.
  • Fiscal balance (% GDP) has decreased significantly suggesting a reduction in financial vulnerability.
  • Public debt (% GDP) has increased significantly suggesting a worsening in financial vulnerability.
  • Reference rate (%) is slightly lower suggesting a reduction in financial vulnerability.
These are the indicators that observers want to focus on in observing the potential for a currency crisis in any given country (although Argentina and Turkey look the most susceptible). In general, the debt levels look like the most dangerous threat. Even though the benchmark interest rates are on average lower relative to 2007 levels, the external debt levels are significantly higher, and because the debt is external, it will be sensitive to the hawkishness coming from developed economies’ central banks. This is one force weakening emerging market currencies.

But that isn’t the only pressure on currencies. Internal turmoil via political uncertainty and/or fiscal irresponsibility is threatening the credit rating of many emerging markets sovereign debt. Interest rates on that debt are increasing in response. That phenomenon cycles back into the foreign exchange market where investors are pushing demand for local currencies lower and, therefore, devaluing the currency more. These two forces together caused the large sell-off on June 14th and could continue to exacerbate an already troubling situation.


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