As MAPFRE Economics experts warn in their latest 2020 Economic and industry outlook report, the economic crisis caused by the lockdown and social distancing measures implemented to tackle the pandemic, “led to the widespread depreciation of emerging market currencies, which, on this occasion, had little to do with the strengths and imbalances of each country’s balance of payments.”

In this case, the drop in exchange rates for emerging market currencies was due to the dual shock triggered by COVID-19: an unprecedented decline in economic activity, paired with an episode of global risk aversion comparable in intensity to the Lehman crisis of 2008–2009. These two factors led to the increase in emerging risk premium and, therefore, the outflow of current account financing (portfolio flows and international credit lines) which has become more volatile.

According to experts such as Steve Englander of Standard Chartered, this exchange rate volatility may have been aggravated in recent years by the low-interest-rate policies of central banks around the world. Under normal circumstances, national economies respond to external shocks by cutting interest rates in order to revive economic activity. In a world of zero interest rates, this is no longer possible, and currency assumes this role, resulting in greater exchange rate volatility.

MAPFRE Economics identifies four distinct groups within the emerging markets: (i) those with current account surpluses and therefore currency stability; (ii) those with a deficit and stable funding; (iii) those with a deficit and flow-dependent funding, and (iv) those with unsustainable deficits.

The first group includes countries that are savings exporters and have a significant current account surplus i.e. China (the world’s largest sovereign creditor) and the oil-producing countries. The two middle groups consist of those countries with relatively manageable current account deficits (with either stable or flow-dependent funding). This covers virtually all of emerging Europe, non-oil exporting countries in Asia (Indonesia, the Philippines, etc.) and large Latin American countries such as Mexico, Brazil, Colombia and Peru.

On the opposite end of the spectrum is the group of countries with large and unsustainable current account deficits, usually owing to structural factors (large structural deficits), low productivity and heavy dependence on external savings, especially on portfolio and credit flows. This group consists of countries that were affected by crises in their balance of payments and draconian adjustments in their activity or exchange rates in 2019, such as Turkey, Argentina and South Africa.

This exceptional situation is expected to last as long as pandemic-induced uncertainty persists at the global level. Countries whose currencies require structural adjustment will remain under a double downward pressure, that exerted by funding and that of domestic vulnerabilities. As MAPFRE Economics experts conclude: “It will be crucial for us to limit the crisis before the liquidity problem becomes a solvency problem and these currencies become even more vulnerable.”