The painful but tolerated devaluations are restoring competitiveness and represent a healthy means of adjustment that was dramatically missing in former crisis.
Have emerging markets found their footing?
Emerging economies have started off 2014 on the wrong foot.
Emerging markets were affected across the globe by the Chinese credit stress; Turkey, Thailand and Ukraine were hit by political turmoil; and Latin America was hampered by Argentina’s decision to devalue the peso. Apart from China, all the mentioned economies have a marginal impact on world growth, but they do generate noise.
While off to a slow start because of emerging markets stress, we think a somewhat positive macroeconomic hypothesis remains valid and will materialise in the coming months, with the largest economies performing largely as expected – China growing about 7.5 per cent, the United States posting above 3 per cent GDP growth, Japan continuing to recover and the euro zone emerging from recession.
Granted, in terms of medium-term perspectives, growth is decelerating and inflation is threatening in emerging markets, including in the former champions – the Brics. Too much reliance on credit, a high dependency on the commodities/Chinese cycle and on external dollar financing definitely reduce their attractiveness for some quarters to come. The recent dramatic capital outflows attest this trend.
Lessons have been learnt. The painful but tolerated devaluations are restoring competitiveness and represent a healthy means of adjustment that was dramatically missing in former crisis.
Some political mobilisation and coordination is also visible, contrasting with the former denial/confrontational postures of former crisis. Indeed, foreign exchange reserves remain significant, and no longer naively dilapidated to confront markets. Central banks have experienced an aggressive sell-off of their currencies, but have quickly responded this time by hiking rates.
The emerging markets’ easing monetary cycle, which began in 2011, has likely come to an end. The vast majority of emerging market central banks are at least on hold, if not in the early stage of a tightening cycle.
Three of the “five fragile” central banks have quickly responded. The central bank of Turkey surprised the market with its very aggressive move to defend the lira. South Africa’s central bank also surprised with a 50 basis point hike. The Reserve Bank of India unexpectedly moved with a hike and sounded somewhat hawkish, while Brazil’s central bank is expected to increase rates later.
We do not view the current shaking as the start of an emerging markets-wide crisis but more as a harbinger of a nascent international cooperation and coordination, as experienced by European Monetary Union countries during the euro-debt crisis.
The global risk aversion has recently spiked, to reach extreme levels. As the Fed’s tapering has started, currencies that have benefited the most from zero-interest rate policies and the three rounds of the Fed bond-buying programme should continue to come under pressure.
The main losers last year – Brazil, India and Indonesia – are reaping the benefits of their currencies’ devaluation, thanks to a gradual improvement of their current account imbalances.
The bearish pressures might remain in the short term on emerging currencies, but we see the first signs of an overshooting. It is very hard to say when the selling stops but one point is for sure: the market is now very long on the US dollar against emerging market currencies. At the same time, some of the most volatile currencies last year remain very well anchored these days.
Emerging countries are engaged in a delicate phase of adjustment, but they are not on the edge of a comparable crisis to former decades. Improvement in the US, Japan and the euro zone and an increase in China activity will provide traction, which will gradually help to restore confidence. We recommend starting to build a basket of emerging currencies at these levels.
Philippe Schindler is the chief investment officer at Blue Lakes Advisors, a Swiss company that advises financial institutions in Europe and in the Middle East