EM economies are fundamentally vulnerable – Nordea Markets

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Analysts at Nordea Markets suggest that EM risks are also rising due to fundamentals and even as emerging Markets as a whole has a zero on the current account balance, but that comes from netting a surplus in Emerging Asia and the CIS with deficits in Latin America and Central and Eastern Europe, which explains that most EM FX sell-off has been seen in the latter two regions.

Key Quotes

“While current account deficits are mostly smaller than in 2013 ahead of the taper tantrum, they remain large in countries like Turkey and Argentina. A relatively high share of FX debt increases the vulnerability for both countries and rising commodity prices put even more pressure on the current account in net commodity importers such as Turkey.”

“Inflation is notoriously the most difficult problem to deal with in EM. Inflation is lower today than before the taper tantrum in 2013 with the exception of Turkey and inflation is still extremely high in Argentina.”

“Bad policies are to blame, and higher rates are needed to stop the vicious cycle of FX weakening leading to higher inflation that again weakens the currency. Argentina has delivered emergency rate hikes, but even at 40%, policy rates do not seem high enough to stop the ARS weakening. Turkey is getting closer and closer to an emergency rate hike, which could easily have been avoided by acting earlier. The CBRT is caught between a rock and a hard place, or rather between President Erdogan, who believes that inflation is caused by too high interest rates, and reality.”

“EM fundamentals are not generally bad in a historical context, but a few Emerging Markets have weak fundaments. Nordea’s EM Traffic Light is built on changes in fundamentals. The reds below show that credit growth, inflation and overvalued currencies are contributing most to higher fundamental vulnerabilities, while higher commodity prices and short-term external debt is an issue for some EM currencies. (Geo)-political risks are not well-captured in the model unless ratings are being downgraded, which means that risks are understated in eg Russia and Turkey.”

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