Some emerging markets, including those integral to the global textile and apparel supply chain, are vulnerable to a monetary crisis that has seen currencies depreciate rapidly against the U.S. dollar in recent weeks, according to a new IHS Markit global market report.
Citing its “External Vulnerability Index,” IHS Markit said emerging markets such as India, Indonesia, South Africa and Ukraine are exposed to varying degrees of vulnerability, with their currencies under pressure and susceptible to a balance-of-payment crisis that has seen emerging market currencies depreciate by roughly 8 percent against the dollar through the end of September.
Meanwhile, currencies like the Turkish lira which has depreciated against the dollar by 37 percent this year, and the Argentine peso, which has depreciated an even greater 54 percent, are even more susceptible to a monetary crisis. Turkey is an important supplier of apparel and textiles to the United States and Europe, and a currency crises could affect the price of raw materials imported by Turkish factories to manufacture their products.
The trouble for emerging market currencies, according to IHS Markit chief economist Nariman Behravesh, started when the U.S. Federal Reserve began tightening monetary policies. The unwinding of certain accommodative conditions that started in late 2008 when the Fed adopted quantitative easing to combat the financial crisis and pushed U.S. interest rates to extremely low levels, have been part of the problem. In turn, emerging market economies needed to borrow more heavily in dollar-denominated debt and as many of these emerging market countries normally run current-account deficits, these factors combined to make them vulnerable to the current balance-of-payments crises.
“The higher external financing costs due to Fed policy tightening has diminished investors’ confidence in the emerging markets’ ability to repay their external debt,” Behravesh said. “This could lead to an abrupt suspension of foreign financing that would force a drastic reduction in current-account deficits. Countries facing this ‘sudden stop’ would reduce their current-account deficit by either curtailing domestic demand or boosting exports. Since boosting exports takes time, most countries adjust in the near term by curtailing demand, which leads to recession.”
The External Vulnerability Index ranks 190 countries based on the stability of their currencies, using measures such as the current account balance, external debt exposure, foreign exchange reserves and inflation. Macroeconomic policy and political risk also are factored into the final ranking. Additional elements of the vulnerability score include countries’ foreign exchange systems, the size of foreign direct investment (FDI) inflow and external debt.
The External Vulnerability Index score correlates with the rank of a country out of the 190 surveyed, meaning a score of 25 indicates a country’s currency ranks as the 25th most vulnerable. Among the most vulnerable of the emerging markets is Ukraine, with a score of 8, while China, with a score of 170, is considered among the least vulnerable.
The South African rand, which has depreciated 13 percent against the dollar through September, will continue to be vulnerable, IHS said, recording a score of 31, with weakness across all index factors except inflation.
Falling in the middle of the index rankings were Indonesia at 74 and India at 81, owing to their high ratios of external debt to foreign exchange earnings. The two countries are important suppliers of apparel and textiles to the U.S., with India second and Indonesia eighth in value terms for the year-to-date through August, according to the U.S. Commerce Department’s Office of Textiles & Apparel.
The Indonesian rupiah depreciated by more than 9 percent through September, while India’s rupee depreciated by just under 12 percent during the same period. This could negatively impact export prices for suppliers in those countries.
“The least vulnerable emerging markets are China and Russia, owing to their persistent current-account surpluses, low external debt exposure and ample foreign exchange reserves,” Behravesh said. “However, Russia is far less robust, owing to geopolitical risks and its open borders to capital movements.”
The U.S. Treasury Department on Wednesday declined to cite China as a currency manipulator, despite the ongoing conflict over its trade practices and complaints surrounding its monetary policy. Treasury Secretary Steven T. Mnuchin said his agency “is working vigorously to ensure that our trading partners dismantle unfair barriers that stand in the way of free, fair, and reciprocal trade. Of particular concern are China’s lack of currency transparency and the recent weakness in its currency. These pose major challenges to achieving fairer and more balanced trade, and we will continue to monitor and review China’s currency practices, including through ongoing discussions with the People’s Bank of China.”
Currencies from Turkey and Argentina, which are among those having depreciated most significantly against the dollar, rank high on the index. Turkey, with a score of 10, “shows danger signs across almost all indicators: high current-account deficit even after accounting for FDI inflows, large external debt exposure, low level of foreign reserves and high inflation,” the report said. Argentina, at 25, “shows vulnerabilities across these measures, except the current account if we factor in FDI.
Other notable countries in the apparel and textile supply chain with a score below 100 were Egypt, Mexico and Colombia. Brazil scored 106, and the Philippines scored 107.