Emerging Market Currency Crisis: Everything you need to know

Emerging Market Currency Crisis: Everything you need to know

When the clock struck midnight on 31st December 2017, emerging-market leaders were surely all praying for one thing; that the good times would continue to roll on into the New Year.

2017 was a stellar year for developing economies. Growth was buoyed by a synchronized expansion across the globe, local stock markets boomed, and still-loose monetary policy in developed nations—particularly the United States—meant currency pressures were minimal.

Annual variation of emerging market national currencies versus USD in % 2018

Yet such an alignment of the stars proved to be as fleeting as a New Year’s kiss. The U.S. Federal Reserve has cranked up interest rates three times so far in 2018 in response to rising domestic cost pressures, with another hike in the offing before the end of the year. At the same time, the European Central Bank has announced the imminent end of its bond-buying program.

Tighter monetary stances in the developed world have put severe pressure on emerging-market currencies, particularly in countries which have one or more of the following characteristics: a sizeable current account deficit, elevated inflation, a hefty external debt burden and heightened political uncertainty. The currencies which have suffered the most dramatic falls from grace, such as the Argentine peso and Turkish lira, suffer from a toxic concoction of all four.

Which other developing countries have seen large currency depreciations this year? What are the internal dynamics driving these developments? And what, if anything, are the authorities doing to stop the rot?

Argentina

2018 has been a horror show for the Argentinian peso. It has been the worst-performing emerging-market currency, down substantially against the dollar since the start of the year. Gaping current account and fiscal deficits, a devastating drought which shrank agricultural production and export revenues, and rising interest rates in the United States have been the main factors behind the selloff.

To address its exchange rate woes, Argentina went cap in hand to the IMF, and on 7 June reached a three-year USD 50 billion standby arrangement that committed the government to push through economic reforms and curb the fiscal deficit. However, in the months that followed, inflation accelerated sharply and the currency continued to crumble. With President Macri’s chances of being reelected in the 2019 elections dimming by the week, there was growing uncertainty surrounding the administration’s ability to implement the reform program.

In response, the Central Bank hiked the policy rate from 40.00% to an excruciating 60.00%—the world’s highest—at the end of August. Several weeks later, the IMF announced a revised bailout package, with USD 7.1 billion of addition funds, sharper fiscal consolidation and a rigid 0%-monthly-growth rule for the monetary base through June 2019.

Restoring confidence is key to the success of the new monetary and fiscal strategy. If economic operators regain confidence in the peso, the currency will stabilize and interest rates on Argentine bonds will fall, leading to an improvement in the economic situation. Otherwise, monetary tightening could translate into stubbornly high interest rates and a lack of liquidity, damaging economic activity.

Argentinian Peso Exchange Rate Forecast

FocusEconomics Consensus Forecast panelists are downbeat about the currency’s future prospects despite the administration’s concerted efforts, and see the peso ending 2018 at ARS 42.2 per USD and 2019 at ARS 50.1 per USD.

Brazil

Political noise combined with lackluster economic data and a broader selloff of emerging-market assets have weighed heavily on the Brazilian real this year. The real has lost around 20% of its value since the start of 2018 and hit an multi-year low of 4.21 BRL per USD on the 13 September. A volatile political environment has largely driven the currency’s loss, with general elections to be held on 7 October. Reforms are much needed to correct fiscal imbalances; however, it remains to be seen whether the new president will have the ability or willpower to implement such tough measures, which have fallen to the wayside in the run-up to the vote. Meanwhile, economic data has been downbeat and provided little support for the real.    

Despite pressure on the currency, the Central Bank has held the benchmark SELIC interest rate at a record low of 6.50% after reducing it to that level in the first quarter. Economic slack has kept inflation in check for most of the year and justified an accommodative monetary policy stance. However, price pressures have amplified in recent months and some FocusEconomics analysts are penciling in rate hikes in the coming quarters.

The real is likely to remain under pressure in the coming weeks as the political situation remains turbulent ahead of a likely second-round runoff. Moreover, the real is at risk of plunging further if the incumbent fails to prioritize curbing the ballooning fiscal deficit and the economic environment remains challenging.

Brazilian Real Exchange Rate Forecast

Our panelists currently see the real ending 2018 at BRL 3.73 per USD and 2019 at BRL 3.68 per USD.

India

2018 has been a bruising year for India’s rupee, which has fallen to a record low against the dollar in recent days. The losses mainly stem from domestic economic imbalances, with the merchandise trade deficit reaching multi-year highs in recent months. This is partly due to a resurgence in oil prices, which are currently trading at over USD 80 per barrel, the highest reading in over three years. Given that India imports over 80% of its oil, rising oil prices have put enormous pressure on its merchandise trade balance and are also a reason for recent inflationary pressures.

In addition to higher oil prices, the more general pull-out from emerging-market assets in recent months has affected Indian capital markets and weakened the current account. Outflows from Indian stocks and bonds have ensued and the Sensex stock market index, which performed strongly in the first part of the year, has fallen sharply since August. The 10-year bond yield has also risen.

In response to the wilting currency, the Indian government raised import taxes on USD 12 billion of goods in late September. This came soon after other similar measures were taken to reduce imports and shore up economic imbalances.  However, this move is unlikely to be well received by the country’s main trading partners, and robust domestic demand sucking in imports could limit its near-term impact.

Indian Rupee Exchange Rate Forecast

Going forward, FocusEconomics panelists see the rupee ending FY 2018—which ends in March 2019—at 70.1 INR per USD and FY 2019 at INR 69.4 per USD.

Indonesia

While Argentina and Turkey have been engulfed by sudden, spectacular currency crashes this year, markets have eaten away at Indonesia’s currency in a more gradual, yet equally corrosive way. The rupiah is down nearly 10% against the dollar so far in 2018, hovering near lows not seen since the 1997–1998 Asian financial crisis.  The country’s weak external position—the current account deficit bulged to a multi-high in Q2—has put the rupiah firmly in the firing line as investors retreat from emerging markets and seek refuge in the U.S. bond market.

In response to the currency weakness, authorities have acted by the book. The Central Bank has raised interest rates five times this year and is intervening regularly in the FX market, while the government has announced a series of measures to curb imports—including delaying certain import-heavy infrastructure projects.

Indonesian Rupiah Exchange Rate Forecast

Looking ahead, our panelists see the combined efforts of the government and Central Bank slowly bearing fruit. They forecast the rupiah to strengthen to IDR 14,663 per USD by the end of 2018 and IDR 14,449 per USD by the end of 2019.

Pakistan

The rupee has shed over 10% of its value against the U.S. dollar to date in 2018, driven largely by domestic imbalances, and Pakistan’s finance minister recently described the country’s precarious economic situation as “on the precipice of a crisis”.

Newly-elected Prime Minister Imran Khan certainly has his hands full. Aggravated by rising oil prices, the merchandise trade deficit reached USD 10.6 billion in the second quarter of this year—the highest on record—feeding through to a weaker current account position. Together with a whopping fiscal deficit and high public debt, this is sapping investor confidence in the economy, eating into international reserves and putting downward pressure on the currency.

In response, on 18 September the government announced that it would raise import duties on 5,000 items—including cars, mobile phones and jewelry—cut spending on infrastructure projects and hike income taxes. So far, the measures appear to have stopped the currency rot, although it remains to be seen whether they provide any lasting support to the rupee.

If not, Prime Minister Khan is soon likely to take the well-trodden path to the IMF (since the late 1980s, Pakistan has taken 12 loans from the Washington-based institution). Indeed, during the final days of September, the government met with IMF officials, with a possible bailout likely discussed. The government is also thought to be seeking financial support from organizations such as the Saudi Arabia-based Islamic Development Bank.

Pakistani Rupee Exchange Rate Forecast

Going forward, the fate of the rupee will depend to a large extent on both the government’s success at reducing the large twin deficits and the degree of international support available. FocusEconomics Consensus Forecast panelists see the rupee ending FY 2018, which ends in March 2019, at PKR 131 per USD and FY 2019 at PKR 134 per USD.

Russia

The Russian ruble has weakened notably so far in 2018, chiefly weighed on by geopolitical uncertainty. The country’s tense relationship with the West and the implementation of fresh sanctions by the United States, not to ignore the broader selloff in emerging-market assets sparked by Turkey’s currency crisis, drove the ruble to lose over 10% of its value in the first nine months of the year and to hit an over two-year low of 70.5 RUB per USD on 10 September.

The ruble’s decline has begun translating into higher price pressures in Russia’s economy, which are likely to continue to mount in the coming months. In response, the Central Bank responded swiftly and hiked interest rates in September, while also halting official USD purchases to shore up support for the currency and contain future inflation. The tighter monetary policy stance saw the ruble to appreciate in value in the second half of September.

Uncertainty over U.S. sanctions remains the key risk to the ruble’s trajectory and could continue to spark volatility in the exchange rate going forward. However, a responsive Central Bank, firmer oil prices, a large current account surplus and a sound macroeconomic backdrop should provide support for the currency, despite geopolitical uncertainty.

Russian Ruble Exchange Rate Forecast

FocusEconomics Consensus Forecast panelists see the ruble regaining some more lost ground and ending 2018 at RUB 66.9 per USD and 2019 at RUB 65.7 per USD.    

South Africa

The rainbow nation’s currency has endured anything but a storm-free 2018, with the rand losing significant value as the short-term tailwind provided by the election of Cyril Ramaphosa as president late last year subsided.

The considerable depreciation in recent months can be pinned on the shaky fiscal, external and political panorama. Investors expecting a rebound in economic activity following the change in leadership have had their hopes dashed. The economy remains comatose, contracting in Q2 in quarter-on-quarter terms. Moreover, the current account deficit has widened markedly in H1, coinciding with a slump in mining production. There is also uncertainty about property rights after Ramaphosa’s announcement in July that he intended to amend the constitution to allow for land expropriations without compensation. 

The authorities’ policy response to the depreciation has been muted thus far. The Central Bank has refrained from raising rates due to the sickly economic outlook—although the latest policy meeting in September highlighted the split within the committee, with several members opting for a hike. Notwithstanding the lack of action, the rand did claw back some ground in September.

In order to build on these gains, the mid-term budget review in October will be key, and investors will be looking for a firm commitment to fiscal consolidation. Such a commitment would also help safeguard the country’s only remaining investment-grade credit rating, from Moody’s.

South African Rand Exchange Rate Forecast

Going forward, the rand is likely to remain volatile, and our panelists see it ending 2018 at ZAR 14.12 per USD and 2019 at ZAR 13.73 per USD. 

Turkey

The Turkish lira has taken a beating so far in 2018; it is the second-worst performing emerging-market currency after Argentina. However, unlike many other countries, Turkey’s currency woes are largely self-inflicted. The government’s prolonged stimulus drive from 2017 stoked overheating concerns, spurred inflation and caused the current account deficit to balloon.

The administration’s initial response to the plunging lira was unconventional. The government announced fresh fiscal stimulus measures, President Erdogan repeatedly lambasted the prospect of high interest rates, and the Central Bank appeared reluctant to tighten its stance, denting investors’ confidence in monetary policy independence. Events came to a head on 10 August, when the lira lost 16% of its value in a single day on seething geopolitical tensions with the United States. Since September however, a semblance of calm has been restored to the market; after weeks of dragging its feet, the Central Bank finally implemented the huge hike in interest rates markets had been waiting for—from 17.75% to 24.00%—and the government announced a fiscal austerity drive. The government’s finance minister has also ruled out introducing capital controls.

Turkish Lira Exchange Rate Forecast

That said, the lira is likely to remain vulnerable to changes in market sentiment going forward. Investors’ faith in fiscal and monetary policy has been shaken and will take time to recover, while Turkey is still at loggerheads with the U.S. administration. FocusEconomics Consensus Forecast Panelists see the lira ending 2018 at TRY 6.46 per USD and 2019 at TRY 6.73 per USD.

Conclusion

When looking at how these different emerging-market countries have faced currency weakness, common patterns emerge. Most of the central banks have hiked rates, while several governments have attempted to trim imports—and by extension demand for foreign currency. However, sticking to economic orthodoxy has in most cases merely stemmed, rather than reversed, currency losses in the face of the Federal Reserve’s inexorable tightening machine.

Three key lessons can be gleaned from this. The first is that once investors begin to lose confidence in a country’s currency, the process is often difficult to reverse. Argentina is a case in point. It threw the kitchen sink at markets, with the Central Bank jacking up interest rates to an eye-watering 60% and the government announcing tough spending cuts as part of an IMF program. Yet markets merely shrugged.

The second is that announcing policy changes is one thing, but unless investors believe the government will actually deliver (or still be around to deliver—take Mauricio Macri’s uncertain reelection prospects for example) then all the sweet nothings in the world won’t provide currency support.

The final lesson is that in order to alter exchange rates in a lasting way, governments must decisively tackle the root cause of the depreciation, which in most cases is a weak fiscal and external position. Without such an adjustment, next year could prove just as torrid as 2018 for emerging-market currencies.  


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Date: October 3, 2018

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