Pakistan faces currency crisis danger
Japan’s leading investment brokers and banks have warned that seven countries – Sri Lanka, Egypt, Romania, Turkey, the Czech Republic, Pakistan and Hungary – are now at high risk of a currency crisis.
The Bank of Japan said 22 of the 32 countries covered by its “Damocles” internal warning system had experienced increased risks since it was last updated in May, with the largest increases seen in the Czech Republic and Brazil.
The number of results generated by the model for all 32 has increased markedly from 1,744 since May to 2,234.
“This is the highest total since July 1999 and not far from the peak of 2,692 at the height of the Asian crisis,” said economists at Nomura, calling it “an ominous warning sign of growing broad-based risks in EM currencies.” .
The model analyzes eight key indicators – the country’s foreign exchange reserves, exchange rate, financial condition and interest rates – to come up with an overall result.
Based on data from 61 different EM currency crises since 1996, Nomura estimates that a score above 100 indicates a 64 percent chance of a currency crisis occurring in the next 12 months.
Egypt, which has sharply devalued its currency twice this year and filed for an International Monetary Fund (IMF) program, now has the worst possible score of 165.
Next is Romania at 145, which supports its currency by intervention. Currency crisis-hit bailouts Sri Lanka and Turkey scored 138 points, while the Czech Republic, Pakistan and Hungary scored 126, 120 and 100 points respectively.
Nomura also used the Damocles model for the G7 group of leading economies, with results showing that all but Japan now have Damocles scores above the 100 threshold, led by the United States and the United Kingdom.
Emerging markets are even more vulnerable. Most have yet to fully recover from the COVID-19 pandemic and are now facing high inflation, limited fiscal space, negative real interest rates, a weakened balance of payments and reduced foreign reserve coverage.
“It is somewhat surprising that there have been no major currency crises in emerging markets this year,” added Nomura.
“On the other hand, the challenge of the European Championship is far from over… The late Professor Rüdiger Dornbusch once said: Crises last longer than you think and then happen sooner than you think.”