First it was Argentina, quickly followed by Turkey. Now anxious investors and policy-makers are watching with alarm the plummeting currencies of several emerging-market economies, most of which have borrowed heavily in dollars.
The nosediving currencies are prompting fears of a repeat of the 1997 Asian financial crash or the "Tequila Effect" of Mexico's 1994 financial crisis. Or is something even worse coming — a financial contagion to compare with 2008?
Argentina's peso dropped 29 percent against the U.S. dollar in August, the worst performer among major emerging-market currencies. Turkey's currency followed closely, with a 25 percent slide.South Africa's rand saw an almost 10 percent drop. The Indonesian rupiah fell to its weakest level since the 1997 Asian financial crisis, while India's currency slid into unprecedented territory against the dollar.
September has seen no major uplift in those currencies. The Turkish lira is down 40 percent to the U.S. dollar this year, sparking mounting alarm over the sustainability of the country's sizable dollar-denominated debts held primarily by its banks and businesses rather than the government.
The foreign exchange markets are jittery with traders watching to see if more countries start joining the troubled list, which would indicate contagion is underway. African countries like Angola, Ghana, Ethiopia, and Mozambique could be vulnerable. And in a worst-case scenario even more developed economies like Chile, Poland and Hungary, which are also shouldering large foreign-currency debts above 50 percent of their GDPs, could be impacted, say some financial analysts.
Corporate debt in emerging and developing economies is significantly larger than it was before the 2008 global financial crisis.The bigger the debt, the harder the fall.
"The risk is increasing in those countries," Bertrand Delgado, director of global markets for Societe Generale in New York, has warned.
There is general consensus why emerging markets are in turmoil. Three main developments are blamed:
1 - The impact on market sentiment from U.S. President Donald Trump's tit-for-tat trade war with China and others
2 - Rising U.S. interest rate that has prompted global investors to exit emerging markets to chase yield in dollar investments
3 - The winding down of post-2008 quantitative easing by the U.S. Federal Reserve and the European Central Bank, which has reduced liquidity and the availability of cheap money for governments and businesses in emerging markets to borrow.
A global financial crash?
Marcus Ashworth of Bloomberg cautioned last week the emerging-markets sell-off looks contagious.
"The difficulties for emerging markets have entered a new phase.What were once clearly country-specific crises, well contained within their borders, are bleeding across the world," he warned.
Ashworth, a columnist and a veteran of the banking industry, most recently as chief markets strategist at Haitong Securities in London, added, "One emerging country's problems have become other emerging countries' problems, and it's hard to see how to break the cycle."
Other analysts dispute that contagion is underway, saying each of the troubled states have their own idiosyncratic problems and country-specific challenges, although they acknowledge the turmoil could mount with the U.S. Federal Reserve expected to raise interest rates several times this year.
In a note to investors, DBS, a Singapore-based international financial services group, warned the currencies of Argentina and Turkey "have been struggling with rising U.S. rates since the start of the year, due to deficits in their fiscal and current account balances.
"Heightened trade tensions threatening to erupt into a full-blown trade war could prompt, DBS said, disorderly capital outflows leading to "financial instability, especially in countries that have high external debt levels."
Britain's The Economist magazine argues the weakness in emerging-market currencies "is not fundamentally contagious" and the fallout can be contained.Western lenders including banks will be impacted, it said, as emerging-market borrowers struggle to repay dollar and other foreign-currency debts now worth more in terms of their own currencies. "But it would not threaten their [Western lenders'] solvency," it said.
Optimists say for all the wider currency woes and the economic weakness of Argentina and Turkey, many major emerging-market countries are doing well.
India's GDP was growing at an 8 percent rate ending June. Mexico's peso is steady and it appears to have concluded trade negotiations with the Trump White House, which markets are viewing favorably.
The optimists say the global scare is being fanned by screaming, doom-laden headlines, pointing out that in 2013, when the U.S. Federal Reserve started to cease Quantitative Easing, Brazil, India, Indonesia, Turkey and South Africa all suffered from currency depreciation, but they soon regained their footing.
The biggest emerging-market risk, though, is that rattled global investors could be so alarmed by currency turmoils that they ignore economic fundamentals and stampede away from emerging-market countries, compounding currency falls, triggering indirect contagion, and adding to debt burdens.