What do emerging market currency woes mean for China?

Updated 2018-05-18 10:33:06

In the week since Argentina sought IMF help to arrest a sharp fall in the peso, the Turkish lira, Hong Kong dollar and Indonesian rupiah have all needed official pledges of support after similar plunges.

With risk-averse investors avoiding emerging markets amid ongoing global uncertainty, how many more growing economies will be forced to find external help, and how will the nervous climate affect China?

Plummeting peso and lira losses: What's going on?

Last week, Argentina reached out to the International Monetary Fund after two weeks of currency volatility. The peso is now the worst performing emerging market currency of 2018, and three separate interest rate rises failed to stem its collapse.

As well as calling for IMF help, the central bank has auctioned off 25 billion U.S. dollars' worth of short-term securities at 40 percent interest, and put around five billion US dollars' worth of forex reserves up for sale at a price of 25 pesos to the dollar. Analysts have cautiously called Buenos Aires' supportive moves a success.

On Wednesday, Turkey's central bank was forced to officially announce "necessary steps" will be taken to support the lira, after the currency hit a record low of 4.50 to the U.S. dollar. Analysts now expect Ankara to announce interest rate rises within the next week, as the country struggles with high inflation.

Markets had initially reacted negatively to President Erdogan's comments earlier this week, when he said he would look to have greater monetary control after June's snap general election, and rejected the idea of raising interest rates.

Moody's has described Turkey as an "overheated economy," while many analysts expect inflation to reach 15 percent later this year if no urgent action is taken on low interest rates.

Wednesday also saw Indonesia's rupiah plunge to a three-year-low, after Jakarta surprisingly announced a trade deficit of 1.6 billion US dollars for April, against an expected surplus of around 700 million US dollars. Again, an imminent hike in interest rates is expected to stem the currency's downturn.

On Thursday morning, the Hong Kong Monetary Authority (HKMA) was forced to support the Hong Kong dollar for the 16th time since April. The HKMA is required to sell forex reserves and buy the Hong Kong dollar if the local currency drops to 7.85 per US dollar, and has now bought 67.2 billion Hong Kong dollars (worth around 8.56 billion U.S. dollars) to support the currency.

The JPMorgan Emerging Markets Currency Index fell by as much as 1.4 percent on Tuesday, as concerns also grew over local currencies in Egypt, South Africa and Ukraine.

Why is this happening now?

While individual factors specific to each economy are affecting emerging market currencies, the main reason across the board for struggles in 2018 is the strength of the U.S. dollar, increased yields on U.S. Treasury bonds and strong economic data coming out of Washington. Expected interest rate rises from the U.S. Federal Reserve are further increasing the pressure on emerging markets.

With Treasury bond yields hitting near seven-year-highs, emerging markets have seen high levels of capital outflows in recent weeks. The rise of the U.S. dollar also pushes up the cost of borrowing for emerging markets, which typically have high levels of external debt.

While emerging markets can still offer much higher returns than U.S. Treasury bonds, concerns over the economic policies of U.S. President Donald Trump, ongoing tensions on the Korean Peninsula and Iran are pushing investors to take less risks and flock to so-called safe haven investments.

What does it mean for China?

Economic instability in emerging markets will be a concern for China, which has forged close trade and financial partnerships with many emerging economies.

However, in terms of investment opportunities, many analysts believe China could actually stand to benefit. Foreign investors can now access more Chinese assets than ever before, thanks to Stock Connect programs between Shenzhen, Shanghai and Hong Kong, and the inclusion of more than 230 domestic shares on the MSCI Emerging Markets index.

With strong economic data in recent months, a stable currency and an increasingly open economy, more investors are looking at China as an alternative to both the U.S. and other emerging markets.

According to Xinhua, weekly net inflows of funds from Hong Kong to the Shanghai and Shenzhen stock exchanges have risen for consecutive weeks since the end of March.

BYNicholas Moore

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