A financial trader monitors her computer screen at the Bombay Stock Exchange in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Emerging-Market Slump Shows IMF Reserves Endorsement Little Help

(Bloomberg) -- Ever since Thailand ushered in the Asian financial crisis by burning through its foreign-exchange reserves, those stockpiles have served as a gauge of resilience when turmoil erupts. This time round, the measure is looking shaky.

Sure, there’s good correlation between the relatively low holdings in Argentina and Turkey and the slide in their assets. But India has the worst-performing exchange rate in Asia so far this year, and it has almost double the reserve "adequacy" ratio set by the International Monetary Fund. Asia’s top performer, after the safe-haven yen, is the ringgit -- despite Malaysia’s reserves being almost as sub-par in the IMF’s calculation as Argentina’s.

The discrepancy supports the idea that investors may be doing a lot more due-diligence this time round as they reassess their appetite for riskier securities. Currency-reserve adequacy may tell a different story than a track record -- such as in Malaysia -- of credibility in holding down inflation and sustaining economic growth.

Emerging-Market Slump Shows IMF Reserves Endorsement Little Help

"It is wrong to extrapolate the problems of Argentina and Turkey to other EMs, since their fundamentals are more unique and an exception to the progress that has been made in large parts of the asset class," Morgan Stanley strategists including James Lord wrote May 7. "Current levels represent a tactical opportunity to add risk."

One bet Morgan Stanley is making: going long the South African rand against the euro. And that’s despite the country having a worse reserve-adequacy rating than Argentina -- at least, before Argentina sought a back-up credit line from the IMF.

The reversal for many emerging markets in recent weeks has taken some by surprise, after they had outperformed developed markets in the first quarter. The MSCI Emerging-Markets Currency Index suffered its worst month since November 2016 in April as the advance in U.S. Treasury yields finally gave flight to the dollar. One gauge of emerging bonds has the worst return for the year to date since 2004.

Central banks in developing economies from Argentina to Indonesia have intervened to defend their own currencies, depressing reserves that were at varying levels of adequacy according to the IMF scale, as seen below.

CountryYTD FXCurrent AccountReserves CoverReservesAdequate Level
(%)(% GDP)(%)($ Billion)($ Billion)
South Africa-2.6-3.1855059

NOTE: Czech Republic, Taiwan and Israel, which are also members of the Bloomberg Barclays’s emerging-market bond index, are excluded due to lack of data from the IMF. Current account balance in percentage of GDP in the table are based on economists’ estimates compiled by Bloomberg.

“Economies with insufficient reserve levels, large external debt and a deficit in the current account are more vulnerable in a rising interest-rate environment,” said Shigehisa Shiroki, joint general manager at Mizuho Bank Ltd.’s Bangkok treasury. “They may have to accept a weaker currency, but that would be a problem because it causes faster inflation.”

The message from the varied performances among developing countries may be that investors need to do their homework. Reserves, along with current accounts, inflation and growth rates -- not to mention political risks -- all feed in.

Malaysia’s surprise election result this week shows the potential impact of political risk. The ringgit’s one-month non-deliverable forwards dropped to a five-month low Thursday after the opposition ended the six-decade rule of Prime Minister Najib Razak’s party.

Ahead of the election, the ringgit had fared better than its peers this year, despite a relatively weak reserves ratio. With economic expansion forecast in excess of 5 percent this year by the IMF, Malaysian markets offer a test of whether investors are still attracted to the faster growth offered by emerging markets.

“Gone are the days when you can buy any emerging market so long as benchmark rates in developed markets were low and it was crisis-free,” said Tsutomu Soma, the general manager for fixed-income trading at SBI Securities Co. in Tokyo. “It’s becoming all the more important to decipher each country’s fundamentals; be it current account or reserves.”

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