Emerging market FX growth underperforms broader market

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Emerging market (EM) currencies are expected to continue to expand their share of the $5.3 trillion-a-day global forex market despite the turmoil, with China’s RMB leading the charge.

However, EM FX growth structurally underperforms nominal GDP expansion while Aussie dollar flows are more important than the Brics in aggregate.

Yet there are dissenters challenging static theories that have cast the rise of the EMs in stone.

Contributing around 50% of global GDP at purchasing-power parity, the EMs account for just 20% of worldwide forex turnover, which remains dominated by the dollar and the euro.

The Bank for International Settlements’ latest triennial survey shows EMs’ share edged only slightly higher from the 19% they accounted for in 2010, but the performance must be seen against a global forex market that has grown by a third during that time.

EM currencies, which accounted for just 15% of global turnover in 2001, now occupy two of the top-10 most-traded spots – the Mexican peso and the renminbi. The peso is the eighth most-traded currency by doubling its share of global turnover to 2.5% from 2010.

However, the rise of RMB has been meteoric, coming virtually out of nowhere in 2007 – when it was ranked 20th, accounting for just 0.5% of global turnover – to become the currency with the ninth-highest turnover, with 2.2% of the global market. By currency pair it’s a similar story: USD/CNY turnover has surged 265% and now accounts for 2.1% of all trades in which USD is on one side.

There is evidence that the pace of the RMB’s integration into the global financial system is accelerating as demand for the currency grows and restrictions are relaxed.

Premier Li Keqiang recently reiterated China’s commitment to actively move towards a market-based RMB exchange rate and to gradually achieve full convertibility of RMB under the capital account.

Western Union Business Solutions says it has seen strong growth in direct RMB payments to China by its clients in the first half of this year.

The firm says US clients’ RMB payments were up almost 90% from the same period last year and now account for 12% of all payments to China. Australia saw a 50% jump in RMB payments while payments from the UK rose 40%.

The explosion in use of RMB comes in part as a result of a widening of a pilot scheme permitting 60,000 Chinese firms to accept direct international RMB payments to virtually every company in China. Payment in a suppliers’ own currency can offer substantial cost benefits and other advantages.

“China is already in the top 10 in terms of overall volume and should catch up further with G5 currencies in the years ahead, provided they continue to pursue their liberalization programme, which premier Li has re-emphasized recently,” says Javier Corominas, head of economic research and a portfolio manager at Record Currency Management.

“The Chinese leadership has laid out a detailed and sequential plan of action where further and quicker liberalization is in view. That’s quite a change from only a few years ago when it was only in Hong Kong where these measures were being tested.”

Corominas says it is encouraging to see the growth of EM currencies in terms of volume and he expects that trend to continue.

“They represent 50% of world GDP at purchasing-power-parity exchange rates, so ideally they should be represented in terms of currency flows in a way that reflects the size of their economies,” he says.

“I see the current sell-off as a cyclical event around an underlying appreciation trend as opposed to a secular shift downwards in terms of emerging market currency appreciation and thus volume.

“Once we get a fuller acceptance of free-floating currency regimes, especially in Asia, and liberalization of capital accounts, then we could see a substantial pick-up in volumes and convergence with their world GDP share.”

EM currencies have been experiencing high levels of volatility for the past four months after the announcement by the US Federal Reserve that it might begin winding down its money-printing stimulus programme.

The ultra-low interest rates produced by quantitative easing saw an estimated $2.26 trillion of capital inflows into EMs in 2011 and 2012 alone, pushing currencies ever higher – but that is now reversing as spooked investors re-allocate funds back to developed markets.

“The dollar is going to be the most safe-haven currency and maybe increase its share from the 87% of trades it already has, mainly because of the US coming back to growth,” says Amir Khan, corporate dealer at Currencies Direct.

“Emerging market currencies will recover, but it’s going to take time – two or three years minimum. It has been a really slow recovery, but once the global economy picks up and emerging markets try to sort out their economies and are less risky, then you’ll see again funds pouring in.


“But the next few years are going to be all about the internationalization of the RMB as China tries to make its currency less dollar dependent, so we’ll see a lot of RMB currency swaps and much more of the forex markets happening from China.”

Others believe weaknesses that rising yields in the developed markets have highlighted in the economies of the EMs calls into question the tenets that plot a linear path to economic dominance for these markets.

“The economic theory being played out that the world is no longer just dollar-centric has got to be proved by seeing non-dollar crosses rise in value and in importance and we haven’t seen that yet,” says Bob Savage, chief strategist at FX Concepts in New York.

“It’s wonderful to say the emerging markets have become much more important but in aggregate they’re just not as important as the euro in trading. Put all the Brics together and they’re not as important as the Australian dollar flows.

“All trading seems to be denominated in dollars and euros; full stop.”

He concludes: “If we were going to see emerging markets rise in importance, it has got to be based on the argument that you’re going to see more self-self trade. That is, more RMB/BRL or more JPY/CNY, or some other currency pairs outside of the norms that we’ve seen rise in cross trading.

“The cross trading share – non-dollar trading – should be rising not falling.”

Source: Bank for International Settlements