Moody's warns of adverse capital flows ahead of Fed

Cape Town - To some extent South Africa counts among the emerging markets most at risk going forward, Moody's said on Thursday.

The ratings agency, which made it clear that its statement was not a credit rating action, was commenting on the possible impacts on global markets should the US Federal Reserve hike interest rates on Friday.

"The most affected large emerging markets - and those most at risk going forward - have tended to be those such as Brazil, Russia, Turkey and to some extent South Africa, in which severe domestic challenges have contributed to exchange rate and financial market instability, and where policy room to buffer external shocks and protect growth is less robust," said Moody's.

It explained that emerging market sovereigns face varying degrees of exposure to rising US interest rates, with those possessing limited buffers and policy space being most at risk to adverse capital flows and investor sentiment.

"Although lower global commodity prices and possible volatility in capital flows will pose challenges to some emerging markets, a combination of reserve buffers and policy vigilance has the capacity to limit the negative sovereign credit impact," said Moody's.

"The big drops in emerging market exchange rates already seen this year were partly in anticipation of a Fed action. Other factors behind these moves included slowing Chinese growth and the related fall in export revenues for commodity exporters."
According to Moody's, when the anticipated Fed move occurs, there remains a low risk of a disorderly reaction should an initial move by the Fed cause investors to abruptly adjust their expectations for yields.

The biggest downward currency moves among the largest emerging markets during the course of 2015 occurred in Brazil, Turkey, Russia, South Africa, Mexico, and Indonesia, with an average depreciation against the dollar of about 17% since the beginning of the year.

"Although currency depreciations can augur well for exports, they tend to be accompanied by turbulence in domestic financial markets, which can affect overall growth," said Moody's.

"Also, sluggish demand in trading partners has limited improvements in export performance in most emerging market exporters, despite the depreciation of their currencies."

That is why Moody's expects that the combination of these factors will lead to slow or negative economic growth in many emerging markets.