Treasury Today Country Profiles in association with Citi

Vulnerable currencies: the storm before the storm?

Fork lightning striking down from a dark cloudy sky

Emerging market currencies have been particularly fragile in recent months but the growing likelihood of a new economic crisis threatens an even greater challenge for treasury FX policies.

The value of the Turkish lira fell by one fifth against the dollar in the space of a few days during August. Argentina’s peso more recently showed a similar fall in just two days, and election uncertainty has put the skids under the Brazilian real. Even the Swedish krona, a less obvious candidate for the currency sick bay, has been looking decidedly off-colour of late.

Little wonder that currency volatility and FX risk management featured high on the agenda last week at EuroFinance’s international treasury management conference in Geneva, where treasurers were warned that the likelihood of a full-blown emerging-markets crisis within the next two years is increasing. As some observed, even the most effective hedging policies are challenged by a 40% currency depreciation in a week.

Last summer’s sell-off focused primarily on Turkey and Argentina, whose massive current account deficits have become a serious problem. This prompted last week’s agreement by the International Monetary Fund (IMF) to beef up its finance package bailout to the key Latin American country.

However, the lira and the peso are by no means the only currencies on the casualty list. Friday’s earthquake and tsunami in Indonesia has only added to the woes of the country, where the rupiah has extended its steady decline this year.

Treasury departments for corporates operating in the emerging markets should prepare for further currency volatility. A further 0.25% hike in US interest rates last week by the Federal Reserve – its eighth since the end of 2015 – suggest that its rate-tightening cycle is some way from completion.

“The probability of higher rates in the US is triggering massive capital flights from heavily indebted countries,” says Antonio Rami, co-founder and chief operating officer (COO) of foreign exchange specialist, Kantox. “At the same time, the depreciation of their currencies makes it much more difficult for them to be able to repay their debts. It’s a perfect storm that pushes these countries towards default.

“For the Asian economies, however, there is a more threatening issue, which is the escalating US-China trade war. Many of the region’s key economies, such as Taiwan, South Korea and Southeast Asia are producers of intermediate products that are sent to China before being exported to the US as finished goods.

“If the tensions between the world's two major economies significantly squeeze exports from China, these economies could see their growth seriously reduced and we could see further currency crisis episodes in Asia.

“Nor can we assume that the consequences will be confined to Asia. It’s easy to see that the consequences of any tit-for-tat escalation between China and the US might spill over to other regions and end up disrupting global commerce and ultimately crushing global GDP growth. However, we still hope that Donald Trump’s approach to tariffs is more a negotiating ploy than a long-term strategy and that, in the end, common sense will prevail.”

Indeed while the US president hails the just-agreed successor to NAFTA, the United States-Mexico-Canada Agreement (USCMA) as “a wonderful new trade deal”, many of its features suggest a rebrand rather than radical change and that compromise is achievable in other trade disputes.

Supporting the rupee

While dire economic fundamentals explain the weakness of many emerging market currencies, they do not apply to India. The world’s sixth-largest economy has boasted an enviable growth rate in recent years, with a figure of 8.2% in the most recent quarter, and enjoys relative political stability under Narendra Modi, prime minister for the past four years.

Yet the rupee’s decline since the start of the year has made it one of the worst-performing currencies of 2018. Government attempts to shore up the currency include a pledge to reduce India’s “non-essential imports” and moves to improve foreign investors’ access to rupee-denominated bonds issued by Indian corporates.

These efforts have been accompanied by intervention by the central Reserve Bank of India to buy rupees and two interest rate hikes this year; none of which have been enough to arrest the slide.

However, Kantox’s Rami points to the steady revival in oil prices over the past couple of years. “India is a net importer of oil and the rising cost of crude is expected to boost the country’s fiscal deficit over the coming months,” he reports.

“At the same time, increased risk aversion caused by the US-China trade tensions have led to some capital outflows this year. In this context, the Turkish lira selloff increases concerns that the crisis could spread to surrounding countries, triggering another bout of capital outflows.”

Among other concerns widely voiced at last week’s Geneva conference is the consequence of recent US tax reform and the possibility that the offshore liquidity of many American companies is repatriated back home.

Company treasurers also expressed frustration at the difficulty of releasing trapped cash from emerging markets. South Africa, which has just entered recession for the first time in nearly a decade, was cited as one of the major culprits.

With so much talk of vulnerable currencies, it’s perhaps ironic that this year’s EuroFinance conference was held in Geneva. The Swiss franc, which dramatically unpegged itself from the euro in early 2015 and jumped by 30%, is again climbing against other major currencies while there is little evidence that this is making life tough for exporters.