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The Emerging Markets Currency Crisis: What Investors Should Know

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As the U.S. dollar rallies, other nations, especially those with emerging markets, are suffering from weakening currencies against the benchmark. Starting with the crash of the Turkish lira a few weeks ago, the Mexican peso, Argentinean peso, South African rand, and Indonesian rupiah have all crashed in a very short span of time.

On Tuesday morning, the rand plunged as much as 3.4 percent after a report showed South Africa has unexpectedly entered into an economic recession for the first time in nearly a decade. The lira also dived as much as 1.3 percent, with it having lost more than 40 percent over the course of this year. Mexico’s peso continued to sink as much as 1.6 percent. Argentina’s peso weakened to a record low value, with the government asking for funds to the IMF. Indonesia’s rupiah fell for a sixth day, diving into a two-decade low.

The main causes of this crisis are a stronger dollar, the intensification of global trade disputes, rising short-term interest rates in the U.S, and a boost in corporate spending. According to Reuters, Michael Every at Rabobank said, “As long as the U.S. continues to raise rates, keep corporate taxes relatively low, blowout the fiscal deficit, sucking in U.S. dollar, and keep trade war fears on the radar, the dollar will remain on the front foot versus emerging markets.”

But emerging market currency crises aren’t new. In 2013, when the U.S. Federal Reserve started to cease the Quantitative Easing program that was initiated in 2008, the “Fragile Five” emerged. Brazil, India, Indonesia, Turkey and South Africa suffered most heavily due to extreme currency depreciation as the Fed cut back its bond-buying program. However, in less than five years, those countries regained their political stability and currency power—for the most part.

This time, economists and investors are worried that it won’t be so easy for the afflicted countries to recover, largely because of debt. Emerging markets are heavily indebted, and a stronger dollar makes it tougher for them to pay that money back.

The main issue is that corporate debt in emerging and developing economies is significantly more than it was before the 2008 global financial crisis. As the volume of debt is much larger, the fall could be more detrimental.

This summer has been tough for emerging market investors. A dilemma for investors is whether to keep investing, hoping the emerging economies will have a comeback, or to step back from these markets for a while, especially during such volatile times.

It will be helpful to note, though, that interest rates are rising in the U.S. and other major economies, making it altogether more difficult to invest in developing markets. Will the emerging market bubble burst? We will still need to see, but the current crisis seems to be a long way from being solved.

Not surprisingly, major exchange-traded funds (ETFs) that track emerging-market equities slid on Tuesday. The Vanguard FTSE Emerging Markets ETF (VWO - Free Report) dived 2.3%. The iShares Core MSCI Emerging Markets ETF (IEMG - Free Report) sank 2%.

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