EM Vulnerability Table Shows Divergences In Fundamentals
by Win Thin
EM currencies are getting hammered in this latest bout of risk off trading, though the performance is very mixed across the asset class. Given that markets are now punishing EM currencies with weak fundamentals or where policy-makers are behind the curve, we think it’s time to dust off our EM Vulnerability Table, something that has been on the back burner since the euro zone crisis first erupted and brought the market spotlight to bear on the Developed Markets and away from the Emerging Markets. We remain bullish on EM in 2011, but believe that investors will be more selective and focus more on the fundamentals rather than just aiming for pure yield. Though we often talk about EM having strong fundamentals overall, it is clear that there are some countries that have growing vulnerabilities that we hope to identify in the table below. It should be clear that EM is not some monolithic entity with identical fundamentals.
We think investors should focus on the twin deficits (budget and current account, both as a share of GDP) as part of an exercise in identifying the weaker EM credits. We add another layer to the analysis by looking at short-term external debt as a share of foreign reserves, as this is where the shifts in investor sentiment will ultimately be manifested. Lastly, high inflation is a growing problem as many countries are trying to target both inflation and the exchange rate with monetary policy. This cannot persist, and we are growing increasingly concerned about countries that are not responding aggressively enough to rising price pressures for fear of triggering greater currency appreciation. The table below summarizes EM vulnerabilities at the end of 2010. As soon as our 2011 forecasts are completed, we will update this table accordingly for this year.