Foreign-exchange reserves are emerging as the latest battleground between traders and developing nations trying to stem the worst rout in their currencies since 2008.
Nations with the smallest reserves to fend off currency speculators will continue to see their exchange rates under pressure, options prices show. Of the 31 major currencies tracked by Bloomberg, traders are most bearish on Argentina’s peso, Turkey’s lira, Hungary’s forint, Indonesia’s rupiah, and South Africa’s rand, while the forwards market signals that Ukraine’s hryvnia will fall 20 percent in a year.
“If you start to burn too quickly through your foreign reserves, it’s an ominous sign—and of course in the forex market, they smell blood,” Robbert Van Batenburg, the director of market strategy at broker Newedge Group SA in New York, said Feb. 5 by phone. “It creates this domino effect.”
From Argentina to Turkey, emerging markets are under siege as the U.S. Federal Reserve pares its record stimulus measures and reports showing a slowdown in Chinese manufacturing raise concerns about the strength of their economies. A Bloomberg index tracking 20 exchange rates has fallen 2 percent this year, building upon the 7 percent decline in 2013.
Turkey spent 27 percent of its foreign reserves trying and failing to defend its currency since June, leaving it with $34 billion as of Feb. 10, excluding commercial banks’ deposits. That’s only enough to cover 0.29 percent of short-term debt, the least among 14 developing nations tracked by Goldman Sachs Group Inc. South Africa’s $46 billion amounts to 13 percent of gross domestic product, less than the 18 percent it needs to finance its trade deficit and debt, according to the U.S. bank.
The lira fell to a record 2.39 per dollar and the rand tumbled to a more than five-year low of 11.3909 last month.
“Burning through their reserves, that’s not sustainable,” Viktor Szabo, a money manager in London at Aberdeen Asset Management Ltd., which oversees $10 billion, said by phone on Feb. 6. “People will be more than happy to short your currencies,” he said, referring to a strategy of betting against an asset. “The pressure was there, and there’ll be more pressure.”
Kazakhstan’s central bank devalued the tenge by the most since 2009 yesterday after its international reserves dropped to about the lowest since 2009, while Argentina spent $25 billion since March 2011 defending the peso, driving the stockpile to a seven-year low. The peso has still weakened 16 percent in 2014.
“Foreign-exchange reserves can be thought of as a shock absorber at times of volatility, allowing EM [emerging market] central banks to buffer their currencies against sharp declines by supplying U.S. dollars to the market,” Goldman Sachs analysts Robin Brooks and Julian Richers wrote in a Jan. 29 report. “Countries with low reserve cover are relatively more vulnerable.”
Both Turkey and South Africa resorted to raising interest rates last month to deter speculators, which Citigroup Inc. warns may trigger a “vicious circle” of slower growth.
Turkey’s central bank increased its benchmark rates to as high as 12 percent at an emergency meeting on Jan. 28, prompting a rally in the lira of more than 4 percent.
South African policy makers unexpectedly raised rates by a half-point to 5.5 percent on Jan. 29, a day before the rand fell to its low. Since then, the currency has rallied 2.8 percent, the best performance among 31 major currencies after the lira and Australian dollar.
“I wouldn’t be short exclusively on the basis that they have little reserves,” Ilan Solot, a strategist in London at Brown Brothers Harriman & Co., said in a Feb. 4 phone interview. "If they don’t start getting their act together, and if reserves continue to be depleted, then we’re rapidly approaching a currency crisis. That thought is unsettling.’’
Across the developing world, borrowing costs still aren’t high enough to protect the “weakest links” among emerging currencies, Citigroup strategists led by London-based Jeremy Hale wrote in a Feb. 6 client note.
“Vulnerable EMs face the risk of falling into a vicious circle,” the strategists wrote. “Weaker growth and higher rates could weigh on local asset markets” and “if this then leads to unwinds, capital outflows could lead to renewed currency weakness, which would require higher rates once again.”
Mark Mobius of Templeton Emerging Markets Group says the exodus from developing nations is “almost over,” while Goldman Sachs Group Inc. Chief Executive Officer Lloyd C. Blankfein argues that these economies are in better shape than during the Asian crisis of the late 1990s. The experience of South Africa and Turkey suggests that not all developing currencies will share in any rebound.
Mobius, whose firm manages $50 billion in developing-nation assets, told Bloomberg Radio yesterday that we’re “nearing the end of this big rush out of” emerging markets.
Blankfein said in a Bloomberg Television interview yesterday that developing economies have “better reserves, more flexibility in exchange rates, better policy” than during the 1998 Asian crisis, when South Korea and Thailand spent billions trying to defend exchange-rate pegs, only to eventually devalue and seek International Monetary Fund bailouts.
Traders are paying a 6.99 percentage-point premium for three-month options to sell the Argentine peso over contracts to buy, the most since September 2012, risk-reversal rates show.
While the premiums for the lira, rand, and rupiah have declined from recent highs, they’re still above the average across emerging markets and higher than levels at the end of October. The gauge for the lira was at 4.04 percentage points, compared with 2.78 on Oct. 31, while the gap for the rand was at 3.39, from 2.94. The rupiah’s rate was 3.91 percentage points, from 3.61, data compiled by Bloomberg show.
Ukrainian policy makers let the hryvnia plunge to a five-year closing low of 8.855 per dollar on Feb. 6 after spending 54 percent of its reserves since April 2011 to keep the currency steady. The reserves declined to an eight-year low of $18 billion in January, from $38 billion in April 2011.
Non-deliverable 12-month forwards for the hryvnia traded at 10.405 per dollar yesterday, implying a 17 percent decline in the currency, according to data compiled by Bloomberg.
In Indonesia, policy makers have given up on using reserves as the main tool for defending the rupiah after spending $20 billion in the seven months through July and still failing to stem the currency’s slide. Instead, officials have reduced fuel subsidies to cut the budget deficit and raised interest rates. The rupiah gained 0.7 percent this year to 12,085 per dollar.
“Everyone is looking to bring rates higher,” Simon Quijano-Evans, the head of emerging-market research at Commerzbank AG in London, said in a Feb. 5 phone interview. “It’s the first step in calming the situation. You cannot continue using foreign reserves if no one believes in your policy.”