SEP 16, 2015 @ 04:24 PM
It’s going to be a hard row to plow for a number of emerging markets if the Federal Reserve Bank raises interest rates on Thursday as some expect. Moody’s said on Wednesday that at least two BRIC markets, namely Brazil and Russia, were in for an even ruder awakening than their domestic economies are already handing to them.
Emerging market sovereigns face varying degrees of exposure to rising U.S. interest rates, with those possessing limited buffers and policy space being most at risk to adverse capital flows and investor sentiment, Moody’s said in a statement today.
The big drops in emerging market currencies this year were partly in anticipation of a Fed action, namely in China and India. But other countries had politics to thank. Brazil is dealing with in-house corruption scandals that’s taken the Brazilian real from around 2.8 to the dollar to 3.8 in less than a year. And a weak outlook for oil, coupled with policy moves at the Russian Central Bank, has the ruble back near 70 again. A stronger dollar will not help these markets.
“If the Fed rates go up 25 bips, this will be just the first step and we will have to see what the market does about that. They will assume more hikes on the way so if we go into a bear market, emerging markets are going down,” says Adam Sarhan, founder of Sarhan Capital in New York. “If Fed rates stay the same, then I think you have a two fold reaction. We will be happy the easy money is here to stay, but also the Fed will be telling you that they don’t think the economy is strong enough to handle 25 basis points. Which brings up the question: if the global economy can’t grow with easy money, how is going to grow with higher rates? We will all be asking ourselves these questions this week.”
Moody’s thinks there is little risk of a disorderly reaction when U.S. interest rates do eventually go higher. The biggest downward currency moves among the largest emerging markets during the course of 2015 occurred in Brazil, Turkey, Russia, South Africa, Mexico, and Indonesia, with an average depreciation against the dollar of about 17% since the beginning of the year.
Malaysia, an energy exporter, also saw a large fall in its exchange rate. Although currency depreciation can bode well for some exports, they tend to be accompanied by turbulence in domestic financial markets, which can affect overall growth, Moody’s stated.
Also, sluggish demand among trading partners — namely from China — has limited improvements in export performance in most emerging markets anyway, despite the price of their goods becoming cheaper due to devaluation. For Turkey in particular, a further weakening of the lira would increase the cost of significant foreign-currency debt. The same holds for Brazilian corporations. The country’s sovereign debt was cut to speculative grade by Standard & Poor’s just last week.
The biggest losers in a Fed hike will be Brazil, Russia, Turkey and to some extent South Africa due to domestic challenges that have contributed to market instability. Their room to buffer external shocks and protect growth is less robust.