EM FX Weekly – We downgrade real and rand

by: Georgette Boele

EM-FX-weekly-10-September-2015.pdf (251 KB)
  • The environment for emerging market currencies remains very negative
  • We have identified the 6 emerging markets at risk
  • We expect more weakness in the real, rand, lira and rupiah ahead.


Top 6 emerging markets at risk

The environment for emerging market currencies remains very negative. There has been a negative feedback loop between lower commodity prices, concerns about the global growth outlook, deterioration in investor sentiment, weak domestic growth and political challenges. In addition, the Fed is expected to start its hiking cycle this year. We judge that Brazil, South Africa, Turkey, Colombia, Malaysia and Indonesia are the most vulnerable (see our Macro Focus: The top 6 emerging markets at risk. The currencies are among the weakest performers this year (see graph below). Our forecasts for the Turkish lira, and Indonesia rupiah already reflect further downside. We decided to adjust our forecasts for the Brazilian real and the South African rand downwards.

150910 EM Weekly

The Brazilian real is treated like a pariah…

The Brazilian real is the weakest emerging market currency in our coverage so far this year declining by more than 40% versus the US dollar. The central bank has halted its hiking cycle and has intervened in currency markets to stem the fall of the real. This week the situation got worse. S&P lowered its long-term foreign currency credit rating for Brazil to BB+ from BBB-. So Brazil falls out of the investment grade category. Moody’s and Fitch still see Brazil as investment grade. The outlook of S&P is negative. All the negative factors are coming together for Brazil. Brazil is a major commodity exporter with substantial exposure to China. In addition, it is in political turmoil, the fiscal situation is deteriorating, the economy is in recession and the central bank is reluctant to ease monetary policy to support the economy because of inflation (the weaker real is further increasing inflation pressures). S&P’s decision will weigh further on the real. We expect more downside in the real this year versus the US dollar. Therefore we have adjusted our year-end forecast for USD/BRL to 4.0 from 3.7.

…and a weaker South African rand in the near term

The central bank in South Africa (SARB) is in a catch-22. On the one hand, the economy is weak, while on the other hand a weaker rand is resulting in upward pressure to inflation. In addition, there are strikes in the mining sector and power blackouts that hamper the economy. With the Fed expected to start hiking this year, the rand will most likely remain under pressure mainly because of weak fundamentals.  Therefore, we lowered our ZAR forecasts further. Our new year-end forecast for USD/ZAR is 14.0 (from 13.5). As is the case for many emerging market currencies, the South African rand is substantially undervalued. So if sentiment on emerging markets eventually improves it is likely that it will rally strongly.

150910 EM Weekly2