Portfolio | EM crisis due to yuan devaluation seems overblown, says Jefferies

The unexpected devaluation of the yuan precipitated a sell-off in emerging market stocks by jittery global investors on fears it could tip many economies into recession as it did in the 1990s. But worries about such a crisis seem a bit far-fetched.

Strategists in Jefferies concede emerging market equities “have entered a ‘riot and revulsion phase’” but reckon the situation has not reached the threshold of a crisis.

“There is an opportunity to distinguish between cyclical economic slowdowns such as high inventory-shipment ratios and structural issues such as capital outflows, weak current accounts and real rates being too low,” Sean Darby, the chief global equity strategist with Jefferies, wrote in a note to clients.

Jefferies strategists led by Darby listed three main differences between what it is going on right now and the 1994-98 emerging market crisis. First, central banks across emerging markets run a floating exchange rate, unlike two decades ago when countries like Thailand and South Korea all had their currencies pegged to the US dollar.

Secondly, this time it is mainly the non-financial firms that will suffer from a heavy exposure to dollar debt, but not those companies that could possibly give rise to sovereign credit risks.

Interest rates were riding high in four of the largest emerging economies while inflation rates were on a decline, a sign that sharp currency depreciation on inflationary expectations was less likely, the strategists said.

It is also worth noting that most emerging economies sit on a much larger pool of foreign reserves compared to the mid-1990s, making them more resilient to heightened levels of currency volatility.