How Brexit Is Likely to Keep Beating Up Emerging Markets

Exchange rate volatility is the primary conduit for post-Brexit fallout in emerging markets

By Ian Talley
.

An Indian man looks on at a local currency exchange shop in Mumbai. Like many emerging market currencies, the Indian rupee fell sharply in the wake of the Brexit referendum, creating fresh vulnerabilities for the economy. (Punit Paranjpe AFP/Getty Images) Photo: Agence France-Presse/Getty Images


Britain’s vote to leave the European Union is inciting fresh turmoil in emerging markets already struggling with broad-based slowdowns. Part of the problem is investors worry growth in industrializing nations will take a hit as prolonged uncertainty weighs on EU output.

But the key Brexit threat is channeled through exchange rates. As British voters voted to exit the EU, investors pulled their cash out of the British pound, the euro and a host of emerging markets, and poured it into safe-haven currencies, largely the dollar.

The Polish zloty, Hungary’s forint and the South African rand recorded some of the biggest moves. As it became clear in the weeks ahead of the vote that a Brexit was far more possible than markets originally thought, the dollar surged. Combined with a long-term strengthening over the past year, the dollar has now up more than 9.4% against a basket of emerging market currencies.                                                                                                                                                                                                                                          
The IMF says that the dollar is already 10%-20% higher than economic conditions warrant, and a prolonged period of Brexit uncertainty is likely to keep driving it higher. Emerging-market currency volatility isn’t likely to disappear anytime soon.
The IMF says that the dollar is already 10%-20% higher than economic conditions warrant, and a prolonged period of Brexit uncertainty is likely to keep driving it higher. Emerging-market currency volatility isn’t likely to disappear anytime soon.

China’s yuan has fallen almost 3% against the dollar in the past several weeks as the Brexit vote loomed ever closer and became a cold, hard reality. Combined with a larger depreciation since June of last year, that is a 6% nominal depreciation.

China’s yuan has fallen almost 3% against the dollar in the past several weeks as the Brexit vote loomed ever closer and became a cold, hard reality. Combined with a larger depreciation since June of last year.

A depreciating currency can be a boon as it makes products cheaper overseas and boosts exports. But that theory works best in practice when there’s global demand for goods: Growth, and along with it, trade, has soured over the past several years. And it also spurs inflation, which can be a major headache when central banks want to cut rates to jump-start growth but feel pressure to raise them to prevent rampant price-increases.

The biggest risk is from debt exposure, however. As their currencies fall and the greenback rises, it balloons the effective debt burden and makes interest payments much more costly.

Dollar-denominated borrowing in emerging markets has tripled over the last decade, in part driven by the unprecedented era of ultra-low interest rates and bond-buying by the Federal Reserve.

China is the largest borrower by far, but other countries have built up sizable debts.

The corporate sector in emerging markets is the most exposed.

But sovereigns could also come under pressure, particularly given that corporate debt could end up on state balance sheets, given the large number of state-owned enterprises, heavy use of state-guaranteed debt and if governments have to bail out stressed financial sectors.

After a slow recovery from the slew of sovereign downgrades created by the financial crisis, credit quality is fast declining.

The turmoil in industrializing economies isn’t as bad as it could be, say many economists. Capital outflows were modest compared to previous bouts.

Robert Kahn, a senior fellow for international economics at the Council on Foreign Relations, says one view is that “as long as China’s economy remains on track, commodity prices hold up, and the Fed is on hold, emerging markets should weather the Brexit shock.”

But, he adds, periods of intense volatility are more likely than not ahead. “We should see today’s bounce as a temporary calm, not the end of the storm.”

0 comentarios:

Publicar un comentario en la entrada