05 July 2015
DOHA: Of 16 selected largest emerging markets (EMs), Turkey, South Africa and Brazil are the most vulnerable economies to a higher US interest rates. Indonesia, Mexico and Argentina are also at risk, according to a QNB economic commentary.
The QNB commentary on "which EMs are most vulnerable to higher US interest rates?" noted yesterday that the main reason for EM vulnerability is a heavy reliance on capital inflows. As interest rates in the US rise, there is a risk that capital could flow out of EMs, into the US to take advantage of higher relative yields. This is what drove the EM capital flight shock in mid-2013--the "taper tantrum"--when the Federal Reserve (Fed) announced that it would begin cutting back its quantitative easing programme, leading to a sharp rise in US and global bond yields.
The EMs that are most vulnerable to this kind of shock are those that are most dependent on capital inflows. A key metric in assessing vulnerability is, therefore, the current account balance--a country with a large deficit is reliant on capital inflows to finance the deficit. The countries expected to have the largest current account deficits in 2015 are Turkey (4.9 percent of GDP), South Africa (4.6 percent) and Brazil (4.1 percent). The other countries that we consider to be at risk all have current account deficits in the range of 2.6 percent-1.3 percent of
A second measure of vulnerability is external debt, which is usually denominated in US dollars. As US interest rates rise and capital flows back to the US, the dollar is likely to strengthen. This increases the value of US dollar debt and also increases the burden of servicing this debt as payments rise in local currency terms. Therefore, countries with high levels of external debt will find it more difficult to meet their obligations and dollar debt will become an increasing drag on the economy.
High levels of external debt will increase investor risk perceptions of a country, leading to a higher risk of a sudden stop in capital flows. The average level of external debt among our selected EMs is 31percent of GDP. Once again, Turkey and South Africa stand out with relatively high levels of external debt (50 percent and 41 percent of GDP, respectively). Indonesia (34 percent) and Mexico (33 percent) also have relatively high levels of external debt.
A final measure of vulnerability is real GDP growth. High growth will raise predicted returns for investors, increasing the appeal of the country. Conversely, low growth will encourage investors to withdraw capital and increase the risk of a sudden stop in capital flows. The Brazilian economy is currently challenged by GDP growth, which is expected to contract by 1.3% in 2015, due to low commodity prices and rising central bank interest rates to combat rampant inflation. For this reason, and given Brazil's high current account deficit, we consider it to be as vulnerable as Turkey and South Africa. Growth in Turkey is expected to be around 3.0 percent in 2015, fairly unremarkable and insufficient to offset the country's external risks.
The countries QNB consider as at risk have relatively diverse real GDP growth rates. Growth in Argentina is expected to be zero in 2015 as the country struggles to recover from its legacy debt overhang. This lack of growth, combined with a current account deficit (1.5 percent of GDP) and moderate external debt (27 percent of GDP), leaves the country exposed if US interest rates rise. Indonesia is expected to grow faster at 5.0 percent, which should help attract some capital despite the external risks. Mexico has similar external vulnerabilities to Indonesia, but lower GDP growth (2.6 percent in 2015).
A Fed rate hike this year appears likely, with a 50:50 chance of a first rate hike in September. Higher US interest rates will probably lead to considerable volatility in global financial markets and elevated EM risk.
DOHA: Of 16 selected largest emerging markets (EMs), Turkey, South Africa and Brazil are the most vulnerable economies to a higher US interest rates. Indonesia, Mexico and Argentina are also at risk, according to a QNB economic commentary.
The QNB commentary on "which EMs are most vulnerable to higher US interest rates?" noted yesterday that the main reason for EM vulnerability is a heavy reliance on capital inflows. As interest rates in the US rise, there is a risk that capital could flow out of EMs, into the US to take advantage of higher relative yields. This is what drove the EM capital flight shock in mid-2013--the "taper tantrum"--when the Federal Reserve (Fed) announced that it would begin cutting back its quantitative easing programme, leading to a sharp rise in US and global bond yields.
The EMs that are most vulnerable to this kind of shock are those that are most dependent on capital inflows. A key metric in assessing vulnerability is, therefore, the current account balance--a country with a large deficit is reliant on capital inflows to finance the deficit. The countries expected to have the largest current account deficits in 2015 are Turkey (4.9 percent of GDP), South Africa (4.6 percent) and Brazil (4.1 percent). The other countries that we consider to be at risk all have current account deficits in the range of 2.6 percent-1.3 percent of
A second measure of vulnerability is external debt, which is usually denominated in US dollars. As US interest rates rise and capital flows back to the US, the dollar is likely to strengthen. This increases the value of US dollar debt and also increases the burden of servicing this debt as payments rise in local currency terms. Therefore, countries with high levels of external debt will find it more difficult to meet their obligations and dollar debt will become an increasing drag on the economy.
High levels of external debt will increase investor risk perceptions of a country, leading to a higher risk of a sudden stop in capital flows. The average level of external debt among our selected EMs is 31percent of GDP. Once again, Turkey and South Africa stand out with relatively high levels of external debt (50 percent and 41 percent of GDP, respectively). Indonesia (34 percent) and Mexico (33 percent) also have relatively high levels of external debt.
A final measure of vulnerability is real GDP growth. High growth will raise predicted returns for investors, increasing the appeal of the country. Conversely, low growth will encourage investors to withdraw capital and increase the risk of a sudden stop in capital flows. The Brazilian economy is currently challenged by GDP growth, which is expected to contract by 1.3% in 2015, due to low commodity prices and rising central bank interest rates to combat rampant inflation. For this reason, and given Brazil's high current account deficit, we consider it to be as vulnerable as Turkey and South Africa. Growth in Turkey is expected to be around 3.0 percent in 2015, fairly unremarkable and insufficient to offset the country's external risks.
The countries QNB consider as at risk have relatively diverse real GDP growth rates. Growth in Argentina is expected to be zero in 2015 as the country struggles to recover from its legacy debt overhang. This lack of growth, combined with a current account deficit (1.5 percent of GDP) and moderate external debt (27 percent of GDP), leaves the country exposed if US interest rates rise. Indonesia is expected to grow faster at 5.0 percent, which should help attract some capital despite the external risks. Mexico has similar external vulnerabilities to Indonesia, but lower GDP growth (2.6 percent in 2015).
A Fed rate hike this year appears likely, with a 50:50 chance of a first rate hike in September. Higher US interest rates will probably lead to considerable volatility in global financial markets and elevated EM risk.
© The Peninsula 2015
