September 10, 2008 / 8:14 AM / 11 years ago

Dollar recovery spurs emerging markets rethink

LONDON (Reuters) - A resurgent U.S. dollar has thrust emerging assets into the forefront of a global markets selldown, just months after they were being touted as the least exposed of investments in the credit crunch.

A resurgent U.S. dollar has thrust emerging assets into the forefront of a global markets selldown, just months after they were being touted as the least exposed of investments in the credit crunch. REUTERS/file

Emerging shares, which initially outperformed their developed counterparts in 2008, have tumbled to their lowest in 1-1/2 years with a commodities price slide pummelling investor favourites Brazil and Russia.

A rush to safe-haven U.S. Treasuries and the dollar have hit emerging currencies and bonds, forcing emerging market central banks to draw on their much-lauded reserves to defend their exchange rate regimes.

Seeing these export-oriented economies as more vulnerable to a deepening world economic slowdown, investors have begun to rebalance their portfolios to factor in prolonged dollar strength and a retreat in commodity prices.

A massive unwinding of carry trade positions — built up by investors using the cheaper dollar to buy higher yielding assets in other currencies — has knocked emerging assets lower.

“It’s clear we’ve had hot money leaving. People had been investing in emerging markets in form of carry trades and these people are exiting. As soon as the money leaves in fixed income, some of it leaves from stock markets as well,” said Philip Screve, a Brussels-based fund manager with Dexia Asset Manager.


The dollar’s advance — barely halted by Sunday’s news of the U.S. government’s takeover of troubled mortgage giants Freddie Mac and Fannie Mae — is fanning concern that some economies could buckle under a rising foreign debt burden caused by the weakening of their currencies.

The greenback’s 10 percent rise against a basket of currencies since mid-July has already prompted central banks from Russia to South Korea to Indonesia to intervene in foreign exchange markets to support their currencies, stirring memories of the 1997 Asian financial crisis when Asian economies were hit by massive capital flight.

A sovereign default is unlikely as forex reserves in emerging economies such as Russia and South Korea remain ample.

But concern over the corporate sector in Hungary, South Korea, Russia and Kazakhstan lingers as firms in these countries had seized on favourable exchange rates to raise overseas debt.

“This is a dangerous environment particularly in those emerging economies where companies took advantage of stronger local currencies to borrow in dollars,” said Jeremy Brewin, an asset manager at Morley Fund Management.

The weakness of emerging currencies coincides with the end of an interest rate tightening cycle as central banks in developing economies shift their focus away from abating inflation to declining economic growth.

The easing of consumer price pressures — led by the nearly 40 percent fall in oil prices since mid-July — is making longer tenor bonds more alluring to some investors.

“Local bonds with long duration look attractive as they pay you high real rates of return over inflation which may be easing,” said New York-based Peter Marber, head of global emerging markets debt at HSBC Global Asset Management.


Weaker currencies coupled with falling foreign investment inflows will worsen the current account deficits of Hungary, Ukraine and South Africa but could boost export competitiveness among emerging economies.

“The rise in the value of the dollar is potentially good for exporters such as Korea,” said Jeff Chowdhry, head of emerging equities at F&C Investments.

The unit’s strength offers relief to Gulf Arab states that have grappled with high inflation exacerbated by their dollar currency peg, argued Kasper Bartholdy, head of sovereign strategy at Credit Suisse.

“The whole inflation problem is becoming much less onerous, as food prices are also coming off.”

Arab Gulf economies are among those where strong domestic consumption and surplus reserves will cushion the impact of a global economic slowdown. Harder hit will be countries that are more dependent on foreign capital flows.

Meanwhile, the notion that the United States will be the first to emerge from the downturn could support investor appetite for Mexico, the top U.S. trading partner, said Nigel Rendell, Royal Bank of Canada’s emerging market strategist.

“The decoupling argument is moot. People now realise that they cannot plough in a separate furrow,” he said.

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