Emerging markets and balance-of-payment risk

SEVERAL emerging market (EM) central banks have hiked interest rates sooner than expected. The culprit: looming balance of payment (BoP) risks, which have crept in on the back of higher US bond yields, US dollar appreciation and higher oil prices. Recently, there has been some respite as US bond yields and oil prices have declined, but this is not the time for EM policy-makers to drop their guard.

To counter the higher BoP risk premium perceived by investors, the central banks of Turkey and Indonesia have hiked interest rates, while Brazil refrained from a widely expected rate cut. In Indonesia and Brazil, the decisions were made despite benign inflation, signalling a proactive move to head off financial-stability risks. If BoP pressures intensify, we could see similar pre-emptive hikes elsewhere - notably India, Chile and Romania. Though not strictly EMs, we believe Singapore and Taiwan are least exposed to BoP risk.

Brazil, which cut interest rates to a record low earlier this year, could start to raise them, while Colombia, Mexico and South Africa could remain on hold if BoP conditions warrant, instead of cutting. EMs with sizable current account deficits - notably Turkey, but also Brazil, Indonesia and India - have generally experienced larger currency depreciations this year. The amount of local government debt owned by foreign investors and the share of corporate debt denominated in foreign currencies are also under close scrutiny. Asia's EMs are also exposed to a global repricing of credit risk, trade protectionism and a China-led economic slowdown.