“[M]ore testing funding conditions following the US Federal Reserve’s forward guidance on monetary policy, slower growth rates, and lower commodity prices add up to a less favorable economic and credit environment for emerging markets,” Fitch said in its “2013 Mid-Year Sovereign Review and Outlook” released late Monday.
Fitch said a prospective tightening in Fed policy settings raises risks for “weaker” emerging markets -- even as the US central bank’s exit is expected to be moderate and “orderly” -- as winding down the stimulus will “generate periodic bouts of market volatility.”
“Market volatility creates its own problems and can feed on itself. Losses can trigger fund redemptions and forced selling,” Fitch said.
“Sharp exchange-rate depreciations will raise inflation (at least in the short term) and reduce local purchasing power, which could increase political pressures. Fluctuations in interest rates, credit availability and asset prices, as well as uncertainty, may deter investment,” it noted.
Fitch said volatile capital flows and higher interest rates resulting from an end to the Fed’s asset-buying program amid a US recovery will hit some emerging market (EM) economies harder than others.
“The most vulnerable will be EMs with large external financing requirements (current account deficits and maturing external debts), low foreign reserve buffers, high levels of leverage, vulnerable debt structures (foreign currency, short maturity and non-resident creditors), those that have seen strong inflows of hot money and recent bank credit growth, and those with weak policy macroeconomic frameworks or weaker fundamentals as signaled by low ratings,” Fitch noted.
In a “heat map” illustrating emerging economies’ vulnerability to a sudden drop in capital inflows -- measured by indicators like state of external finances, public finances and bank credit levels -- Hungary, Jamaica, Lebanon, Mongolia, Turkey, and Ukraine showed at least three indicators in red, “signaling risky or stretched levels.” Countries like China, Indonesia, Poland, Egypt, Sri Lanka, and Dominican Republic had at least two red indicators, indicating moderate vulnerability. Economies like Argentina, South Africa, Romania, Vietnam, Tunisia, Ghana, Serbia and El Salvador, which showed several yellow and a few red indicators on the map, were subject to “lesser potential stress,” Fitch said.
Among the 31 emerging markets covered, only the Philippines and Nigeria did not have yellow nor red indicators, reflecting external positions and credit fundamentals that are stronger than those of the other economies.
Fitch’s map showed that, based on latest data, the Philippines’ current accounts and net foreign direct investments as percentage of the economy are at 2.3%. Countries with red indicators had this ratio in negative levels, such as Lebanon (-9%), Jamaica (-5.7%), and Turkey (-5.4%).
Moreover, the Philippines’ gross external financing needs stood at just 0.2% of foreign currency reserves, in contrast to the likes of Ukraine, with 161.1% ratio, and the Dominican Republic, 138.4%.
“Record foreign exchange reserves provide many countries with substantial buffers to cushion the pressures on balance of payments and currencies, and capacity to maintain foreign-currency payments,” Fitch said.
The Philippines also fares well in terms of debt position, with the share of its foreign currency-denominated liabilities in total outstanding debt only at 19.3%, lower than those of most emerging economies, such as Jamaica (72.4%) and Lebanon (59%).
At the same time, Fitch noted that “[a] greater share of EM sovereign debt is in local rather than foreign currency compared with the past, reducing the vulnerability of balance sheets to exchange-rate depreciation.”
Data of the Bangko Sentral ng Pilipinas show the Philippines had $81.64-billion international reserves as of end-June, already 93.84% of the central bank’s $87-billion projection for the year.
The government is cutting foreign debt to reduce its exposure to foreign exchange risks, and to help manage inflows into capital markets.
Fitch said emerging markets with better credit fundamentals would be “more resilient” to a “global liquidity shock” that could be brought about by Fed’s scaling-down of its stimulus program. Since late-May, US central bank officials have been saying they could start reducing a $85-billion monthly bond-buying stimulus this year in the face of economic recovery. Improved US prospects, in turn, have lured funds away from emerging markets.
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