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Emerging markets are under pressure but growth is expected to accelerate

posted onMay 23, 2018
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Emerging market currencies are under pressure as a surging dollar, higher US bond yields and strength in crude oil prices, are fuelling bets that central banks from India to Mexico will raise interest rates faster than economists anticipated.

On Monday, South Africa’s rand hit a five-month low early in the day, Russia’s rouble was treading water after central bank chief Ksenia Yudayeva said the recent rouble weakness would only marginally affect inflation while the Turkish lira dropped as much as 1.6 percent to a record 4.5586 to the dollar according to Reuters.

The US dollar index, or DXY, is up over 6% since mid-February. While the DXY’s recent strength reflects gains against the euro and Japanese yen, the greenback has also recorded solid gains against all emerging markets currencies since April 24. HSBC, Europe's largest bank, says this may be a sign of growing financial and economic contagion risks. It is also particularly wary of nations that have large external debts and run current account deficits.

“We remain cautious towards EM FX as currencies, particularly the higher yielding ones, are struggling to stabilise,” it said in a note. “A stronger USD alongside firmer US yields does not bode well for EM FX. All the more so when we throw higher oil prices into the mix. “This combination last occurred in November 2016 and September 2017, and EM FX also struggled versus the USD during those episodes.”

The reason for the growing concern is clear but attention can be focused on more positive factors. 

Although, emerging markets have suffered in recent years due to low commodities prices and slower global demand, their economies are growing more quickly than at any time since the crisis with many analysts expecting their aggregate GDP to rise by as much as 5 per cent this year, far more than in the developed world. 

The IMF in its latest World Economic Outlook published last month, said that growth in emerging market and developing economies will rise before leveling off. Prospects remain favourable in emerging Asia and Europe. Along with China, several other emerging market and developing economies will also do better this year, the report said—that group includes Brazil, Mexico, and emerging Europe. The aggregate gains for this country group are, however, weighed down by sharp downward revisions for a few countries in the grip of civil strife, notably Libya, Venezuela, and Yemen. Growing trade and investment continue as notable factors powering the global upswing.

Emerging market stocks have also performed well for the past two years, they have historically bounced back from external shocks, and they displayed a healthy resilience amid choppy trading in early 2018. 

A potential trade war between the United States and China weighed on market sentiment in the first quarter of 2018, but emerging markets as a group, ended the the three-month period in positive territory, outperforming their developed-market counterparts. The prospects for emerging markets stocks remain sound despite the recent increase in volatility, as they are still attractively priced compared with those in developed markets.

Latin America was the top-performing region over the quarter with Brazil and Peru recording double-digit gains over the quarter. Egypt, which made a committed step toward economic reforms was among the top emerging-market performers. In Asia, Pakistan, Thailand and Malaysia stood out while in Europe, Russia and the Czech Republic posted the strongest returns, according to Franklin Templeton Emerging Markets Equity.

Emerging-market economies look poised for further growth.