Nomura sees acute risk
These EU countries are threatened with a currency crisis
By Stefan Schaaf
08/24/2023, 11:35 am
Investments in emerging markets promise high returns, but are risky. Nomura Bank’s “Damocles Indicator” shows how risky it is. The result: three EU countries are right at the top of the list of endangered countries. The warning for a candidate for the euro was particularly surprising.
After the recent increase in yields, fund companies are once again increasingly promoting investments in emerging economies in Asia, Latin America and Eastern Europe. But the group of emerging countries remains risky when it comes to investing, and some of them are threatened by currency crises. The investment bank Nomura warns of this in a study. Turkey, the Czech Republic (member of the European Union since 2004), Sri Lanka and Romania (member of the EU since 2007) are particularly at risk.
“In our view, the trio of shocks – the pandemic, war and high inflation – has widened the disparity in economic fundamentals in emerging markets,” said Rob Subbamaran, Nomura’s head of global macro research. “That is, in some countries fundamentals are relatively healthy, while in others fiscal positions have deteriorated significantly, along with widening current account deficits, insufficient foreign exchange reserve coverage and sharply negative real interest rates.”
Four other crisis candidates
Nomura calculates a so-called Damocles indicator that identifies countries that are threatened by a currency crisis in the next twelve months. A wide variety of fundamental economic data – from the household balance sheet to the development of real interest rates – are incorporated into the indicator. They lead to a value that indicates an acute risk of a currency crisis above the threshold of 100 points. Nomura calculates the indicator for 31 countries. “Damokles” has correctly predicted around two thirds of the past 61 currency crises since 1996.
In addition to the four countries of which Turkey has the highest risk, according to Nomura, Chile, Hungary (since 2004 EU member state) and Brazil also have data that are close to the acute risk threshold. “We take this as a warning about the latent vulnerabilities in emerging markets built up by the pandemic, the Russia-Ukraine war, the rise in global inflation and the subsequent aggressive global rate-hike cycle, and the strong US dollar.” Like Romania and the Czech Republic, Hungary is contractually obliged to introduce the euro. The current situation will certainly make this more difficult.
Czech koruna threatens devaluation
While Turkey is in trouble, particularly due to its erratic monetary policy, and Sri Lanka due to its high debt to China, the warning for the Czech Republic is likely to come as a surprise. After all, the krone is staying relatively constant against the euro. However, Commerzbank warns that there could be a risk of devaluation in the coming year. “The main risk is that inflation does not fully settle to the target level, which will again affect the central bank’s credibility,” it said. “In addition, a controversy has erupted between the government and the central bank as the latter criticizes the expansionary fiscal stance as the main culprit for high inflation.”
The article first appeared at Capital.de