Mexico, Colombia Join The “Fragile Five”

Mexico and Colombia have now joined the “fragile five” grouping of emerging market (EM) economies, replacing India and Brazil, according to JPMorgan, the Financial Times (FT) reports.

The two Latin American nations will now join Turkey, South Africa, and Indonesia to form the group of EM countries seen as the most overdependent on volatile foreign investment flows.

In August 2013, as the U.S. Federal Reserve (Fed) was considering when to wind down its quantitative easing (QE), Morgan Stanley identified the five major emerging markets with the most vulnerable currencies, which at the time was: Brazil, India, Indonesia, Turkey, and South Africa.

The original fragile five were worst hit as the Fed weighed scaling back its QE, which rattled markets as foreign investors fled emerging markets, in what was known as the “taper tantrum” of 2013.

JPMorgan warns that parts of Latin America are among the most exposed to a similar repeat, as an interest rate hike by the Fed is widely expected soon.

Super Taper Tantrum: Can Latin America Weather The Coming Economic Storm? http://t.co/AgJ1LAeHnj pic.twitter.com/CmiqTYIGfE

— EMerging Equity (@EM_Equity) May 11, 2015

Colombia has plummeted down the rankings due to its heavy dependence on oil exports, particularly for government revenues, and a hefty current account deficit of 5.8 percent, which needs to be funded by capital inflows, the FT reports.

Colombia’s current account deficit is now among the largest in the emerging markets as the plunge in oil prices has taken a toll on its finances, according to Capital Economics.

Colombia’s peso has fallen over 20 percent versus the dollar so far this year and has fallen 37 percent versus the dollar in the past 12 months.

Exchange traded funds (ETFs) that track Colombian equities have also suffered badly.  Both the iShares MSCI Colombia Capped ETF and Global X FTSE Colombia 20 ETF have tumbled over 30 percent this year and have plunged over 55 percent over the past 12 months.

“If you are dependent on other people’s money and then the price [of your major export] falls you have a big problem,” said Andres Garcia-Amaya, macro research analyst at JPMorgan, told the FT.

The Global X FTSE Colombia 20 ETF

Mexico is seen as vulnerable due to its reserve coverage ratio, or foreign exchange reserves divided by its funding gap — the capital which is needed to balance its current account deficit, repay short-term funding, and compensate for loss of foreign direct investment — is at just 1.6 years, far less than the 7 years of Russia, another struggling oil exporter, the FT said.

Additionally, Mexico is constrained by its near-zero real interest rate, which leaves it with little room to cut rates should its economy weakens.

“Mexico, a country that many investors consider a safe haven, is now showing up as a high-risk emerging market,” Garcia-Amaya told the FT.

Mexico’s peso has fallen nearly 10 percent versus the dollar so far this year and has fallen over 20 percent versus the dollar over the past 12 months.

ETFs that track Mexican equities have also suffered —  the iShares MSCI Mexico Capped ETF has fallen over 8 percent so far this year and has tumbled 23 percent over the past 12 months, the SPDR MSCI Mexico Quality Mix ETF is down over 6 percent this year and has tumbled over 21 percent over the past 12 months.

The iShares MSCI Mexico Capped ETF

JPMorgan warns that Turkey and South Africa remain the highest risk nations, as both have large external imbalances and significant political risk, with Turkey — particularly reliant on short-term funding — now the most fragile of all.

Maarten-Jan Bakkum, senior EM strategist at NN Investment Partners, believes that South Africa, Turkey, and Brazil are the most fragile, due to their external deficits and strong credit growth since the financial crisis, followed by Colombia, Thailand, Malaysia, and China.

“The more fragile countries now are the credit junkies. In this environment where growth is slowing, where there is pressure on companies’ margins, the corporate side is the one we should be most worried about,” Bakkum told the FT.

Esty Dwek, global strategist at Loomis Sayles, believes that Turkey and Brazil are the most vulnerable, followed by South Africa, Indonesia, and Malaysia.