Wed, July 06, 2022


The underlying causes of the latest EM currency depreciation

THE MAJORITY of countries across the globe have been performing pretty well, thanks to the global trade expansion and expansionary phase of the current economic cycle.

Evidently, countries with outstanding economic performance are emerging countries with GDP growth of more than 5 per cent for those economies as a whole , the strongest since 2014. The robust economic growth together with expansionary monetary policy of major central banks have led to large foreign capital inflows into these emerging countries.
Unfortunately, due to increasingly heating economy, one of the major central banks decides to tighten their monetary policy after a long period of massive liquidity injection through QE programme and extremely low interest rate target. 
After the tightening, outlook has been supported by several important economic indicators such as core inflation of more than 1.9 per cent and unemployment at near historical low of about 3.9 per cent. The financial markets of many emerging countries faced wild rides (MSCI Emerging market index dropped more than 10 per cent from its peak in January 2018), in particular, from the rapid and considerable foreign fund outflows despite the strong outlook of the emerging economies. One of the underlying reasons for this phenomenon is that US assets have now become more attractive since they provide higher rates of returns in terms of higher bond yields and stronger US dollar. 
Therefore, investors divert their investments from emerging countries back to the US. This can be seen from the increase in US bond yields as well as US dollar value that was closely accompanied by a drop in MSCI Emerging market index. 
Even though most of emerging countries have unavoidably encountered the same fate, the magnitude of the effects varied widely from country to country. The reason behind this is the countries’ external positions, namely the robustness of their balance of payment. 
A way to gauge the healthiness of a country’s balance of payment is not only from how large its foreign reserves are but also how fast the funds can be diverted somewhere else if something goes wrong. 
For example, Thailand and Indonesia both have international reserves of more than 8 months of imports, which are quite large compared to the rule of thumb of 3 months of imports. However, for Thailand, the surplus of foreign funds are mainly from current account surplus, which constitutes mainly of trade surplus and foreign tourism income. 
These types of foreign currency receipts cannot be diverted back. In contrast, Indonesia’s foreign currency receipts are largely from foreign portfolio investments and these can be diverted quite easily, ie foreign investors can just liquidate the assets and take their money somewhere they find more attractive.
Therefore, US dollar received through current accounts can be considered as less volatile compared to the one received through portfolio investments. That is why a large chunk of US dollar can be pulled out of Indonesian market quite rapidly when the market saw higher yields for US government bonds, which has caused a strong depreciation of Indonesian rupiah of more than 1.5 per cent in just a week, while foreign capital outflows from Thailand are quite small compared to the inflows through current accounts. As a result, the baht depreciated only 0.8 per cent in that week.
Emerging markets have to encounter more intensified fluctuation not only in the financial market, but also in real market as the real economies could be greatly affected by trade protectionism and fluctuating commodity prices caused by resurfacing geopolitical risks in the Middle East after the US walked out from the Iran nuclear deal and re-imposed sanctions on Iran.
Even though emerging market outlook this year remains robust, investors must bear in mind the larger volatility especially in the financial market, eg exchange rates and bond yields. 
Therefore, identifying, understanding and hedging risks is always a good strategy in this highly volatile environment. 

Views expressed in this article are those of the author/s and not necessarily of TMB Bank or its executives. Contributed by DUANGRAT PRAJAKSILPTHAI and POON PANICHPIBOOL. They can be reached at [email protected]

Published : May 24, 2018