Which emerging nations face the biggest risks in the current investor sell-off?

Turkey and South Africa. These are the two markets facing the highest risks in the current investor sell-off in emerging markets, according to a UBS Global Research report titled ‘Cross Asset Macro Strategy:Stumbling, not falling’ dated January 27.

A low savings rate, high foreign exposure and rising political challenges are key problems in both countries, the report notes.

Turkey has the added problem of a big rise in leverage (debt), with continued external financing important for stability,” it says.

These two markets could be the epicentre of weakness in mainstream EM.”

(Note: This report came out one day before the Turkish central bank hiked a key interest rate (the overnight lending rate) by a hefty 4.25 percentage points to 12% in a bid to persuade investors to hold on to their lira, instead of selling them for US dollars)

However, the problems in these two countries are unlikely to drag other emerging markets into a whirlwind of financial contagion, the report predicts.

In the currency markets, the Turkish lira, the South African rand, the Chilean peso and the Russian ruble are likely to face the biggest challenges, the report says.

Despite all the doom and gloom, UBS, like many other investment houses, remains upbeat on two emerging markets: Mexico and South Korea.

The report notes that while Asia will be able to withstand contagion pressures, even though ASEAN and India “could find themselves in an unpleasant financial grind occasionally, even if full-blown financial crisis is unlikely in Asia”.

Part of this can be credited to the fact that most Asian nations have more sound balance sheets than emerging economies in other parts of the world. Only two countries had wide current account deficits last year in the region: India and Indonesia.

India has taken significant steps to reduce the size of its current account deficit in recent months and the devaluations of both the Indian rupee and Indonesia rupiah have helped, along with tighter monetary policy, the report notes.

“…the risks of contagion causing problems particularly in India in our view are materially lower than this time last year,” the report notes.

(For a quick understanding of what a current account deficit implies, I recommend this investopedia link.)

Of course, if the sell-off in emerging markets picks up pace, Asia will, no doubt, be affected. If capital flows to Asia start to decline, Taiwan and South Korea are likely to be the least vulnerable and most resilient to liquidity pressures.

We suspect ASEAN markets will likely take this harder, where political challenges (Thailand), a still wide current account (Indonesia) are likely to be headwinds, and even countries with better macro such as The Philippines can suffer badly from liquidity drying up after being a popular (and expensive) market for much of the last couple of years,” the report adds.

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