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Is the emerging market currency sell-off nearing its end?

Currency gyrations are notoriously difficult to predict, but the worst may be over.

Is the emerging market currency sell-off nearing its end?

How far the emerging market currency sell-off has to go is the million dollar question that few - at the minute - would dare to answer.

Since the first week of August, when the turmoil began, the Brazilian real, Indonesian rupiah and Mexican peso have all fared particularly badly, and of the top 10 fallers, eight also capitulated to the slide back in May.

While the main catalyst  for each of these bouts of unrest has remained unchanged - investor's fear of the Federal Reserve's tapering plan - this time additional stresses and strains are also at play, and all of them have thrust a spotlight on to emerging markets' weaknesses.

Commodities and credit

Given that all of the EM currencies have succumbed to the current sell-off, it's hard to argue the Fed's move to tighten the stimulus tap is not to blame, though it is not the sole trigger, analysts believe.

'Six of the worst performers are commodity currencies and three countries have experienced a rapid expansion in credit that has called into question the sustainability of economic growth,' said Capital Economics' Neil Shearing, the consultancy's chief emerging markets economist.

Looking down the list of big fallers it's easy to see spot the pattern Shearing has picked up. South Africa, Chile, Columbia, Malaysia and Indonesia have all been damaged by the end of the resources boom and their currencies have shown the strain, while Turkey and Thailand have been hurt by freer credit. The Brazilian real has been battered by both, though Shearing also pointed to the 'obvious' common thread that runs through virtually all of these countries: fairly substantial current account deficits.

1990s all over again?

But an imbalance between imports and exports does not have to be too problematic, and a return to the 1990s is not on the cards, reassured Investec Asset Management's Max King.

The strategist said that while emerging market equities, bonds and currencies have all undeniably had a 'dismal' few months, investors should not be readying for a repeat of the collapse seen two decades ago because of emerging markets' increasing dominance.

He pointed out the role of their assets within global economies had grown significantly since the last emerging market crisis, with some 7,000 investible companies now booming and a total market valuation of $4 trillion, roughly a third of total global market cap.

Emerging market debt is also set to double over the next decade and while this indicates a reliance on foreign capital, it is also an investible theme.

'Investors in sovereign debt can add value from the currencies and bonds of 70 disparate countries, also adding value from duration, inflation-indexed and dollar debt as well,' King argued, pointing out that investors can also exploit the differences between emerging markets, and warning this clutch of countries should never be lumped together.

Moreover, while currency weakness does pose a threat - namely in the form of higher inflation, higher rates and lower growth - EM governments have acted to overcome these obstacles.

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