Recovery For Emerging Markets Currencies Depends On Global Economic Rebound, Restored Commodity Demand

Currencies in some of the major emerging markets, including Brazil, South Africa, Mexico and Turkey, have plunged in value this year, with little chance of recovery until at least next year, raising the potential for inflation and default on debt payments.

Brazil’s real, South Africa’s rand and Turkey’s lira have fallen at least 20% versus the U.S. dollar while the Mexican peso has declined about 15% -- all the more alarming because the drops occurred as the dollar itself hit a two-year low against a basket of major global currencies, including the euro.

U.S.-based fund managers withdrew billions of dollars from stocks and bonds in emerging markets in March and April as the COVID-19 pandemic took hold, which, in turn, led to many of their currencies plummeting.

The World Bank estimated in June the emerging markets and developing economies will see their economies contract by 2.5% this year, the first shrinkage for the group as a whole in decades.

Brazil, India, Russia and South Africa have also been particularly battered by the pandemic and related lockdowns.

A sudden drop in the value of a nation’s currency can lead to severe inflation while making it harder to purchase imports or pay foreign debt.

For some nations like Turkey, Brazil and Mexico, their currencies are unlikely to recover until they see a rebound for their raw materials and commodities – and that can happen only when the global economy strengthens and demand is restored.

“What emerging markets are going to need are real signs that the global economy has healed,” Mark McCormick, global head of foreign exchange strategy at TD Securities, told the Wall Street Journal. “They need that return to normal growth. They also need that pickup in commodity demand.”

In Brazil specifically, the government has committed huge expenditures to assist virus-affected businesses and the jobless, thereby worsening its budget deficit.

“That’s going to come back to bite [Brazil] at some point in the future,” Ilan Solot, global currency strategist at Brown Brothers Harriman told the Journal. “We’re going to have a lot more to worry about when the bill comes for a lot of these countries.”

How successfully these countries battle the pandemic will also play a role in their attractiveness as investments.

Charalambos Pissouros, senior market analyst at JFD Group, said the pandemic has badly hurt emerging markets.

“Advanced economies as a whole are forecast to tumble 8% and although emerging markets are expected to contract only 3%, we have some economies that stand out, like Brazil, Mexico and South Africa and Russia, which are forecast to tumble 9.1%, 10.5%, 8%, and 6.6%, respectively,” he told Finance Magnates. “On top of that, Brazil, Russia, Mexico and India, Peru and Chile are among the top 10 nations … with the most infected cases from coronavirus worldwide, with Turkey and South Africa taking the 15th and 16th places, respectively. So we have several emerging markets on the top of that board, which is worrisome in regards to their respective economies.”

Turkey’s lira has been hurt by rising inflation, slowing economic growth and swelling joblessness.

“We’ve seen unemployment at about 14% [in Turkey], we’ve seen dwindling foreign exchange reserves, growing unemployment, and there’s been really two years of [Turkey] having negative data and macroeconomically being quite vulnerable before COVID,” Alistair Schultz, chief market analyst at ACY Securities told Finance Magnates. “So now we’ve got tourism all but evaporating, we’ve seen the [International Monetary Fund] offer support and [President Recep Tayyip Erdogan] … has basically rejected that as well, and at this point, the central bank has been fighting like crazy to [boost the lira] … but it feels like a losing battle on the Turkish side.”

Moreover, as U.S. equity markets have surged this year, there is little appetite among U.S. investors for volatile foreign assets like emerging market currencies.

“In a world where the S&P 500 and the Nasdaq are doing so well, there’s not a rush to capitalize on emerging markets,” Solot said.

In its recent outlook on emerging market currencies, Lazard Asset Management wrote: “There is little doubt that emerging market currencies are cheap as they absorbed much of the shock from the [COVID-19] crisis. … In order for currencies to revert to more normal valuation levels, we would need to see a shift to structural weakness in the U.S. dollar, evidence of emerging markets growth outperforming developed markets growth, or both.”