No emerging market crisis here in Asia

December 7, 2015 4:14 PM (UTC+8)

 

“US Rate Rise Could Hurt Emerging Markets, Says Bank for International Settlements” was the headline in today’s Wall Street Journal. Asia Unhedged doesn’t observe any crisis symptoms in our part of the world. In fact, the dispersion between risk barometers in Asia and other emerging markets is at an all-time high.

A basic gauge of country risk is the volatility of the national currency, as measured by the price of options on its exchange rate vs. the US dollar. As seen in the chart below, Brazil risk has been at or close to five-year highs, while Indian currency risk is close to five-year lows. Turkey is more like Brazil, and Malaysia is more like India. In fact, the whole concept of emerging markets (let alone “BRIC’s”) is more confusing than enlightening.

Implied Volatility of 3-Month Options of Selected EM Exchange Rates vs. the US Dollar
Implied Volatility of 3-Month Options of Selected EM Exchange Rates vs. the US Dollar

It’s true that Latin American commodity producers are suffering from the consequences of Fed tightening and its impact on commodity prices. Fed tighening pushes up the dollar, and a scarcer dollar depresses commodity prices.

Trade-weighted Dollar Index vs. Industrial Metals Index
Trade-weighted Dollar Index vs. Industrial Metals Index

The commodity producers, though, matter a lot less than they used to in world trade. Asia’s share of world trade–overwhelmingly manufactures–has risen from 30% to 40% of the total in the past 10 years.

Share of World Trade by Region
Share of World Trade by Region

Brazil and other commodity producers have plenty of debt, to be sure. But most of the post-2008 issuance of emerging market debt was taken down by mutual funds rather than banks. It is held by cash investors rather than levered bank positions. That means there are no knock-on effects in the event of a sharp decline in debt prices or even default, because the debt is not used as collateral for borrowing. Brazil can get into serious trouble, but the impact on the world financial system will be small.

Meanwhile the collapse in oil and commodity prices continues to represent a net benefit to Asian commodity importers. Valuations may be high or low, but the era of Asian contagion is long gone.

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