Copyright Reuters. Illustrative photo of China’s RMB banknotes

Written by Saikat Chatterjee

LONDON (Reuters)–The performance gap between emerging market currencies and developed market currencies has been blown to the largest level in more than a decade, as falling interest rates, economic uncertainty and large-scale capital outflows have dampened investors’ appetite for investment.

According to Nordea Research, 10 major emerging currencies, including the , Brazilian real and Turkish lira, have underperformed developed market currencies by nearly 14% this year.

Graphic. Emerging Market Forex and Developed Market Forex

This is in stark contrast to the aftermath of the 2008/09 global financial crisis, when the same basket of currencies rose as much as 25 percent thanks to massive fiscal stimulus from China, which in turn boosted global growth and commodity prices and helped countries from Indonesia to Brazil recover quickly.

“Many were expecting a strong strengthening of emerging markets …… but that didn’t happen this time as the spread story almost disappeared and we didn’t see a dramatic growth performance,” said James Binny, global head of currencies at Dow (NYSE:) Global Advisors.

Relatively high interest rates in emerging markets have been a big draw for investors, but now central banks are being forced to shoulder the burden of supporting their struggling economies, while policymakers – in the absence of meaningful inflationary pressures – are far more tolerant of currency weakness than in the past.

Emerging central banks have now cut interest rates for 20 consecutive months.

Chart. Emerging Markets and the Performance of the Deutsche Mark

There are signs that the easing cycle may have run out of steam as interest rate cuts have slowed and Turkey and Hungary have unexpectedly raised rates. However, this is little comfort to foreign investors who have made big moves into emerging markets in recent years.

TS Lombard data show that foreign investors’ holdings of major emerging market local currency debt have fallen sharply to near $400 billion from $550 billion at the start of the year.

While investors offset some of the decline by piling into Chinese local bonds ahead of China’s inclusion in the global bond benchmark WGBI next year, the gloomy growth outlook means that outflows from emerging markets remain significant.

Even by the end of 2022, the economies of Brazil, Mexico and Turkey are likely to be about a tenth of a percent smaller than estimated before the virus broke out, according to Capital Economics’ projections.

Graphic. Emerging Market Central Banks

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