How long May the Capital Outflow from Emerging Currencies Last?

Since the beginning of the week the Greenback has been advancing powerfully on the positions of emerging markets' currencies. The main "victims" over the past few days include the South African Rand and the Turkish Lira. USD/ZAR is trading today in the 18.1-18.3 area, exceeding the previous historical highs of 2015. The USD/TRY has already broken its March 2020 peak of 6.6080 and so far has taken a break near 6.70 round figure, but further advancement above the absolute high of 6.7676 (which was only seen in August of 2018) causes less and less doubts in the market and, perhaps, is only a matter of short time.

The Brazilian Real and the Mexican Peso have been more moderate in the last several days, but they have already suffered badly in the course of March, having devaluated by 15% and 25%, respectively. The US Dollar rose against the Russian Rouble by more than 25% over a few weeks by March 15, but further attempts to go even higher were covered by persisting daily sales from $0.55 trillion central bank reserves. The support of the central bank came just in time  because without this support the Russian currency would have slid much more. A continuing pressure on the currencies of BRICS neighbours could have been seen also in the "breakthrough" of the Indian rupee yesterday to another historical low at 76.42 for USD/INR.

It's clear that quarantine restrictions continue in all of the countries listed above, but similar measures with a much more severe epidemic have been taken in Europe and in the United States. However, the forced closure of the world economy could have a less adverse effect on developing economies with a low economic base that at advanced economies like Europe or the United States. The logic of the investment community is quite different: in times of crisis people tend to direct their cash flows only in ultra-reliable instruments, which are considered to be the bonds of only a few major developed countries, and the money flows quickly away from bonds and projects in developing countries that are considered more vulnerable despite much higher potential returns in the longer run. 

For example, ten-year Russian government bonds yield a guaranteed 6.8% year-on-year in Russian Roubles, similar bonds in South Africa promise more than 11% per year from the government in local currency, and the yield of Turkish ten-year bonds is even 13.85% annually as for now. But many investors fear the country risks and the exchange rate risks especially. Investors suggest that investing in safe US Treasury bonds at 0.5-0.7% yield only or in the core European countries bonds - which now give a negative or zero "profit" – is more likely in times of global uncertainty.

Even for the bonds issued by Australia or New Zealand, Moody's and Fitch agencies maintain the highest possible investment grade AAA ratings despite the threat of the first recession in 90 years in Australia. Again, the Moody's rating of Russia is only Baa3 now while the same agency just downgraded a similar sovereign credit rating for South Africa on March 31 from Baa3 to the "junk" Ba1 level maintaining a "negative" outlook. The downgrade is due to "continued deterioration in financial stability and very weak structural growth," Moody's said. The Agency refers to the fact that the rapid spread of the virus outbreak will worsen South Africa's economic and financial problems and make it more difficult to take effective policy measures, but it's also worth taking into account that the downgrade itself can worsen the country's financial situation even deeper since this move will lead to South Africa falling out of the FTSE World Government Bond Index. According to Morgan Stanley this could lead to a capital flight of up to $4 billion from the country.

By the middle of last year, the budget deficit in South Africa reached almost 75 billion Rand and topped more than seven % of the entire gross domestic product (GDP) of the country. According to recent data the budget deficit in South Africa still exceeds 50 billion Rand or $2.75 billion in US Dollars. At the same time budget revenues continue to decline both due to the fall in prices for traditional South African export commodities in the context of the global pandemic and due to the relatively prolonged weakness in local consumer activity. And it's not just about quarantine: the income of people is stagnating while real incomes are falling dramatically, the lack of free money and confidence in their future could exacerbate the problems the economy of South Africa had before the outbreak and those troubles with economic stagnation are the same in most of developing countries.

The only difference between them, from a pure financial point of view, is that the South African central bank has the international forex reserves  of just about 54.7 billion in US Dollars that are about ten times less than, for example, Russia, not to mention China or India. Therefore, investors generally feel a little less protection in stability of government bond payments. However, the "airbags" in South Africa or Turkey with their close involvement in regional military conflicts and dependence on supplies to Europe are still not so small that the currencies of those countries would be in a free fall without any limits. So, it's reasonable to say that here everybody is dealing with certain rules of the investment game, and hardly more than that.

In any case, the emerging markets’ currencies show the most interesting speculative dynamics as they are potentially much more vulnerable to further weakening of the global economy than the more stable major currencies like the Euro or the British Pound, or even the Aussie. All of them rebounded last week significantly and now they are trying to keep at least some part of their gains more or less successfully. However, this cannot be applied to the Turkish Lira or the South African Rand yet. And if these currencies fail to present convincing comparable rollbacks against the US Dollar before Monday, this could wave the decline of the previous two days amid few optimism on the US and European stock markets then a further drop in those emerging markets' currencies is likely to continue with additional strength. A downward slide in currency pairs, such as AUD/USD, GBP/USD or EUR/USD, if it occurs, could also be a potential sign that investors still want to avoid risks and may escape from both stock assets and emerging market currencies.

At the same time if the mood on stock markets changes to optimistic over the next few days in a radical way, then the fast recovery of major currencies against the Greenback that began last week could be extended quickly. This alternative scenario could immediately signal a partial return of investments into the assets of developing countries and, therefore, to a rapid rebound of their currencies from the bottom reached.