External exposure of the emerging markets

For some time now, the world of finance has been watching the emerging markets with bated breath, partly owing to the new US trading strategies. In this context, the crisis in Turkey has shown quite baldly how fatal a situation can arise if a critical (economic) policy combines with weaknesses in the external balance of trade. Problematic structures in relation to external balance sheets can send a tense situation into turmoil as key cushions to absorb the shock of the crisis are then lacking. A country with appreciably poor key financial ratios has little scope to err as regards macroeconomic management or political escalation. One can debate how such weaknesses can best be identified, and the list of possible indicators is no doubt long. However, a glance at the classic key external financial ratios – the current account balance, the scale and structure of external liabilities, and the strength of foreign exchange reserves – provides a good starting point.

The chart below outlines a country’s foreign exchange reserves compared to short-term external liabilities plus the current account deficit (such as it exists). While in Russia the reserves clearly exceed the short-term liabilities, the ratio in Argentina and Turkey is exactly the other way round. After all, both these countries post the weakest figures from most angles. We also discern certain deficits for South Africa (current account deficit and reserves that may be expanded), Romania (current account deficit has risen) and Indonesia (relatively low foreign exchange reserves). In Hungary and Chile, the picture could be improved in parts.

We rate countries such as Russia, Brazil and Israel on the solid side. However, it is worth emphasizing that the robust external position grants these countries – which are evidently not consistently unproblematic – a plus point in our ratings, without which the respective rating profile would definitely look worse. Indeed, there is no completely watertight method of warding off all EM storms. A broad change in sentiment, the deterioration in the price of a key export item, or the risk perception rising as a result of tangible political problems could adversely affect countries that generally have good external positions. Critical tendencies get punished quickly, specifically in the foreign exchange market. At the end of 2014, for example, the Russian rouble lost a lot of ground in the wake of the decline in the oil price and the Ukraine crisis, while the Brazilian real is currently suffering from the uncertainty relating to the forthcoming presidential elections. Robust external balance sheets and circumspect policies can at least cushion the negative impact of such factors. By contrast, a weak external position and a counterproductive political situation can, as the example of Turkey shows, translate into a parachute with an awful lot of holes in the silk.




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