Trade, travel, remittance, capital flow links and financial market contagion mean there are few hiding places, within the asset class of emerging and frontier market equities, from factors such as coronavirus disruption, oil price collapse, the declining power of central bank liquidity injections, and, potentially, financial market contagion.
Elevated FX rate risk is an inevitable second-round effect of this.
FX rate vulnerability looks relatively high in the following equity markets in our updated screen (which looks at external debt, current account, real effective exchange rate valuation, import cover, inflation and fiscal balance).
| Region | Country |
|---|---|
| Africa | Egypt, Ghana, Kenya, Nigeria, Tunisia, Zimbabwe |
| Asia | Pakistan, Bangladesh, Vietnam |
| LatAm | None (unless a disorderly IMF negotiation for Argentina) |
| Middle East | Bahrain, Iran, Iraq, Lebanon, Oman |
| Europe-CIS | Turkey, Ukraine |
FX rate vulnerability screen for small EM and FM
Surprising inclusions here are Bangladesh and Vietnam
In the past, for Bangladesh and Vietnam, we have taken comfort in the high growth manufacturing export sectors of these countries and viewed the main risk as an external shock (eg a disorderly China devaluation) as opposed to homegrown vulnerability . However, the following factors merit more attention in the current global environment.
(1) Garments, the 80% driver of Bangladesh exports, have declined yoy since mid-2019. This pre-dated the coronavirus impact (which has disrupted the supply of intermediate garment products from China) and the expected widening of the current account (for the "good reason" of machinery and materials imports related to infrastructure upgrades). Furthermore, growth in remittances offset this garment export decline. There is greater risk to the outlook for remittances after the oil price fall, given over 60% of Bangladesh remittances are sourced from the GCC and almost 10% from Malaysia.
(2) Vietnam external debt is still relatively high (over 40% of GDP) and, if there is a contraction in global risk appetite, this may prove more costly to refinance (particularly when structural reform, liberalisation for foreign capital and privatisation has slowed over the last two years and fiscal deficit has widened).
(3) Both Bangladesh and Vietnam have expensive FX rates on the basis of real effective exchange rates (both in absolute terms and relative to the last 10-year median). That over-valuation arguably makes them more sensitive to any disappointment in news related to the current account or the growth-inflation-fiscal policy framework, compared to, for example, Pakistan, where REER suggests a slightly cheap FX rate on an absolute and relative to historic basis.
Caveat: FX rate prediction is probably the murkiest of all our analysis
This screen is our best effort to identify where there is a high risk of devaluation or increasing capital controls unless pre-emptive action is taken (eg interest rate hikes, credible structural reform).
FX rate risk assessment is necessarily a mix of fundamental variables (the need for capital inflows) and market sentiment (the risk appetite of global and local capital providers and the credibility of policy frameworks in recipient markets).
This screen is also a snapshot; therefore it does not reflect upcoming improvements, such as net oil importer current accounts. Forecasts for current account deficits for the likes of Kenya or Pakistan, should, all other things being equal, improve after the recent oil price collapse.
Related reading
Oil: Not a simple importer (benefit), exporter (cost) dichotomy, 9 March 2020
Oil war: Saudi, Russia can sustain a long war, but a 35% price drop shortens it, 9 March 2020
GCC: Sovereign wealth warning from the IMF (again), 7 February 2020
Coronavirus – The international policy response, 5 March 2020
Coronavirus: Should it be ignored because it is such an unquantifiable risk?, 25 February 2020
Coronavirus: Commodity prices hit as fears grow more global, 3 February 2020
Coronavirus: UAE case a warning for global tourism, 29 January 2020