Emerging Markets: Conditions Are Expected to Remain Challenging
A fall in commodity prices helps countries like India that are large importers. However, for several other nations, especially Russia (ERUS) and Latin American countries, this fall has made their economic situation worse. Several emerging nations were battling with low demand and investment. This fall has made things worse for them.
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A strong dollar (UUP) has had an adverse impact on emerging market currencies. The above graph shows the level of appreciation or depreciation of a currency unit against the US dollar in 2015 YTD (year-to-date). All of the units with index readings above 100 have weakened against the US dollar to that extent. The units below 100 have appreciated against the US dollar. As a result, the euro has gained against the dollar while the Brazilian real has depreciated.
The strong dollar has corporations worried due to the strain it’s putting on dollar-denominated loans on their balance sheets. A change in US monetary policy that wasn’t anticipated could strengthen the dollar more. This could increase the strain on the companies in emerging markets. In some cases, it could even offset the export-related benefits that some of these countries may get.
Capital flow reversal
Monetary policy tightening could also lead to an outflow of capital from emerging economies towards the US. Another factor that’s a risk is the low levels of term premiums in emerging nations. These countries came under the pressure of capital outflows during the taper tantrum episode of the Federal Reserve. Investors and policymakers are worried about capital flight once the Fed tightens the policy.
For investors, an analysis of these risks can present an opportunity to realign their emerging market investments to geographies with prospects that are still attractive.
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