Turkey fallout highlights vulnerability of some EMs

By Janice Roberts

Moody’s Investors Service says the fallout from the correction in Turkey’s (Ba3 negative) exchange rate and asset prices highlights again the external vulnerability and sensitivity to a rise in the cost of debt of some emerging and frontier market nations.

Those economies most sharply hit by weakening exchange rates, wider risk premia and lower capital inflows so far this year share the characteristic of twin current account and budget deficits, while country-specific factors — often relating to policy credibility — have likely also fueled the financial market sell-off.

Moody’s conclusions are contained in its just-released report, “Sovereigns – Global Contagion risks greatest where external vulnerability, weak debt affordability meet low policy credibility”.

The report examines the countries that have been worst hit by a tightening in financing conditions this year. It draws on Moody’s previous analyses of where – aside from Turkey – vulnerability to a sharp and sustained deterioration in financing conditions is greatest.

In this context, Argentina (B2 stable), Russia (Ba1 positive), Brazil (Ba2 stable) and South Africa (Baa3 stable) have seen their currencies depreciate the most against the dollar year to date, while Zambia (Caa1 stable), Argentina, Ecuador (B3 stable), Gabon (Caa1 stable) and Senegal (Ba3 stable) have experienced the sharpest rise in risk premia as measured by bond yield spreads.

Over the past month, South Africa has experienced portfolio outflows. Across the emerging markets, the slowdown in capital flows so far this year has been as pronounced and more prolonged than in mid-2013 when the US Federal Reserve first communicated its intention to taper quantitative easing.

Looking at the size and composition of their balance of payments and the amount of financial buffers in the form of foreign exchange reserves, Moody’s identified Argentina, Ghana (B3 stable), Mongolia (B3 stable), Pakistan (B3 negative), Sri Lanka (B1 negative) and Zambia, beside Turkey, as the emerging and frontier market sovereigns most vulnerable to dollar appreciation.

And out of these, Argentina and Pakistan’s currencies have experienced particularly marked depreciations against the dollar year to date.

Meanwhile, sovereigns with relatively high debt burdens, weak debt affordability and relatively short debt maturities are especially susceptible to a deterioration in their credit profiles in the event of rising government bond yields.

Out of the sovereigns that Moody’s has identified as relatively vulnerable to a sharp and sustained rise in the cost of debt, Ecuador, Gabon, Kenya (B2 stable), Lebanon (B3 stable) and Ghana have seen their risk premia, as measured by EMBI bond spreads, widen the most year to date.



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