World Economy

EM Currencies Crash, Investors Flee

EM Currencies Crash, Investors FleeEM Currencies Crash, Investors Flee

The currencies of Brazil, Mexico, South Africa and Turkey have all crashed to multi-year lows as investors flee emerging markets and commodity prices crumble.

The drastic moves came as fears of imminent monetary tightening by the US Federal Reserve combined with shockingly weak figures from China, which stoked fears that the country may be sliding into a deeper downturn and sent tremors through East Asia, Latin America and Africa, NewsNow reported.

The Caixin/Markit manufacturing survey for China fell to a 15-month low of 48.2 in July, with a sharp drop in new export orders.

Mexico’s peso hit a record low of 16.24 against the dollar. The country’s foreign exchange commission is mulling emergency action to defend the currency, despite the extreme reluctance of the Mexican authorities to meddle with market forces.

Colombia’s peso collapsed 5.2% to a historic low on Friday, a huge move in a single day.

Similar dramas played out in Chile and a string of countries deemed vulnerable to the combined spill-overs from China and the US. The MSCI index of emerging market equities fell to 1.8% to 36.92 and may soon test four-year lows.

 Brazil in Deep Waters

Brazil’s real plummeted to a 12-year low of 3.34 to the dollar, reflecting the country’s heavy reliance on exports of iron ore and other raw materials to China.

The devaluation tightens the noose on Brazilian companies saddled with $188 billion debt taken out during the glory days of the commodity boom. The oil group Petrobras alone raised $52 billion on the US bond markets.

Bernd Berg, from Societe Generale, said Brazil faces a “perfect storm” as the economy slides into deeper recession and corruption scandals spread. New worries about political risk may soon push the real to 3.60, a once unthinkable level.

There is mounting concern that President Dilma Rousseff could be impeached for her failure to stop pervasive malfeasance at Petrobras.

 No Room to Maneuver

In South Africa, the rand plummeted to a record low of 12.68 to the dollar on Friday despite moves by the central bank to defend the currency. It raised rates a quarter point to 6% on Thursday.

South Africa is one of a growing number of emerging market states that has lost its room to maneuver and is being forced to tighten monetary policy into the downturn, compounding the effects of the commodity slump.

Such countries cannot ease policy or resort to stimulus to cushion the blow because this would risk capital flight–and potentially a classic rush for exits. Such synchronized “pro-cyclical” tightening is hazardous for the world as a whole since the emerging markets now make up roughly half the global GDP and–until this year–four-fifths of extra growth.

 China’s Downturn

Stephen Jen, from SLJ Macro Partners, said China’s downturn is proving to be “hard on the outside, soft on the inside”. It may be manageable for China itself as the country shifts from heavy industry to service-led growth, but it is brutal for those countries that have been feeding on the Chinese construction boom.

“China can handle the soft landing; it is the other countries that rely on China’s growth that we worry about,” he said.

Growth in emerging markets–excluding China–has fallen to 0.1%. These countries are on the brink of recession. They are now being hit on two fronts at once since the Fed shows no signs so far of backing away from a rate rise in September, probably the first of many.

 Acute Risks

The complicated “feedback loops” that created an interwoven American-Chinese boom in the last decade–and greatly flattered the emerging markets nexus–are now going into reverse with a vengeance. Jen said the weaker countries face “acute risks of a ‘sudden stop’ in capital flows” when the Fed pulls the trigger. “We expect a violent sell-off in some EM currencies this year,” he said.

Turkish companies and banks have $120 billion of short-term foreign funding that must be rolled over within a year. When combined with the country’s stubborn current account deficit–still 5.7% of GDP–the funding gap is $170 billion. This is more than six times larger than the central bank’s foreign reserves.

The lira weakened sharply to 2.75 against the dollar on Friday and looks likely to test record lows. Yields on 10-year Turkish bonds have jumped 50 basis points this week to 9.48%.