BRACE FOR BUMPY RIDE IN EMERGING MARKETS / THE FINANCIAL TIMES COMMENT & ANALYSIS

December 5, 2013 12:11 pm

 

Brace for bumpy ride in emerging markets

 

By Gillian Tett

 

Banks and hedge funds stealthily creating ‘hit lists’, writes Gillian Tett

 

 

This week, the Indian government can breathe one tiny sigh of relief. After a year in which the rupee has gyrated dramatically, amid fears about a US “taper” and poor growth, the Indian currency hit a one-month high against the dollar of Rs61.53 on Thursday.

 

That is striking, given that “taper” concerns have returned ahead of the next Federal Open Market Committee meeting. And the currency move is doubly notable given that India is now heading for elections that may deliver more political instability.

 

But while the Reserve Bank of India can relax – a touch – right now, the big question is just how many other emerging market currencies will now enjoy similar calm? For as investors look back over the events of 2013, it is clear that one of the most bruising developments in the global financial system was a dramatic return of emerging market volatility.

 

And, as the private and public debates at the autumn International Monetary Fund meetings showed, many policy makers are quietly braced for this volatility to intensify in 2014, not simply because of a possible US “taper”, but because investors are increasingly disenchanted about the emerging markets growth story – and worried about poor liquidity in some emerging market asset classes.

Hit lists

So if this volatility does return, which currencies will be hit hardest? In recent weeks, numerous banks and hedge funds have been stealthily creating their own “hit lists”. But for my money, one of the most lucid frameworks has just emerged from Nomura, which has explored the issue by analysing the link between current account data and foreign exchange swings over the past 30 years.
 
This is a topic that has long fascinated economists and investors; indeed, if you look at how often newspapers mention the words “current accounts” and “emerging markets”, this count has exploded eightfold over the past year. But the Nomura number-crunching suggests that the link between current account data and currency trends is not necessarily as straightforward as journalists – or investors – usually assume.

In the case of developed economies (ie the Group of Ten) the pattern of current account surpluses used to be a reliable guide to future currency trends before 1990; countries with deficits were associated with weakening currencies, and vice versa. But since the early 1990s, this pattern has broken down. Nomura partly blames this on the sheer magnitude of capital flows in the global economy, which means that even high-deficit countries get funding, if – and only if – they are well integrated into global markets.
 
But another critical factor is that countries with big surpluses (say, Japan) have not necessarily grown faster than deficit countries. And Nomura believes currency traders care as much, if not more, about growth trajectories as deficit data.
 
But the picture for emerging markets is very different: in this sector – unlike the G10 – current account data are still a powerful predictor of future currency swings. One reason is that emerging market countries are not always well integrated into global markets. But another key issue is that countries with high deficits generally have lower growth; and vice versa. And when current account deficits expand in a non-cyclical manner, this tends to herald lower growth and looming currency trouble – not just in decades past, but more recently too.


Relief for Delhi

Nomura concludes that countries such as Indonesia, Thailand, Malaysia and South Africa are now very vulnerable to currency swings; since 2006, these countries have seen their non-cyclical deficits increase by 6.5, 2.9, 10.3 and 1.9 per cent respectively.
 
But Hungary, China, Korea, Poland, the Philippines and Mexico are less vulnerable, since all of these, excluding China, have seen improvements in their current account positions. India lies somewhere in the middle of Nomura’s “hit list” (which will come as another point of relief to the authorities in Delhi, given India seemed so vulnerable a few months ago).
 
Now, many investors might dispute this ranking. Judging from the chatter at the IMF meetings, for example, some traders think that Turkey is among the most vulnerable of all. But either way, what is perhaps most noteworthy is that this debate points to a much bigger mood shift.
 
A couple of years ago, it was widely assumed that the emerging markets would move in lock-step with each other; now differentiation is all the rage. That idea might prove to be misplaced if a big shock hits again in 2014; after all, correlation typically soars in a crisis. But right now country picking – like equity stockpicking – is the big market theme. Which is a relief for India; even if it is a curse elsewhere in the emerging market world.
 
Copyright The Financial Times Limited 2013