RaboResearch - Economic Research

Emerging Markets Vulnerability Heatmap


  • Emerging market currencies have seen significant losses since April. TRY and ARS have been the worst performers, losing nearly 40 and 50% respectively
  • A combination of rising interest rates in the US, increased protectionism, higher oil prices and country-specific events have all helped drive losses in EM FX
  • We only expect two more rate hikes from the Fed before the end of next year. That said, if the FOMC does tighten in line with the DOT plot (four more hikes by 2019 year-end) then we expect another round of emerging market currency stress is likely to be forthcoming
  • Rabo’s EM FX Vulnerability Heatmap has helped us navigate the broad-based EM currency sell-offs since we first released it in the midst of the ‘taper tantrum’ back in 2013
  • On these pages we present a ‘new and improved’ version of Rabo’s Emerging Market Vulnerability Heatmap which is constructed from a more comprehensive list of inputs which now covers economic variables, debt dynamics and financial market drivers
  • The Emerging Market Vulnerability Heatmap highlights ARS, TRY and ZAR as the most vulnerable emerging market currencies (from a total universe of 18 currencies)

The perfect storm: 4 factors weighing on EM currencies

2018 has not exactly been kind to emerging market (EM) currencies. After a stellar Q1 when USD weakness helped EM currencies outperform (only TRY lost ground), April ushered in the start of an EM FX rout with every emerging market posting losses against the USD. In fact, some currencies have seen double digit losses during this period (Figure 1). TRY and ARS have been the standouts in this respect with losses against USD of 36% and 47% respectively. So how did EM FX get here and where will they be going?

Figure 1: Many EM currencies face heavy losses since April
Figure 1: Many EM currencies face heavy losses since AprilSource: Macrobond, Rabobank
Figure 2: Oil import constitute 17% of total Indian import
Figure 2: Oil import constitute 17% of total Indian importSource: OEC, UN TRADECOM, Rabobank

A combination of factors are at the root of the global sell-off in EM currencies. First, USD caught a strong bid while other developed market (DM) currencies faded on the back of rising rate differentials as the Fed continued down its path while many other DM central banks took a step back from a tightening bias. This dynamic resulted in a sudden stop of portfolio inflows toward emerging markets which in turn weighed on currencies. Through 2018, it became apparent that impact of FOMC US rates decisions on investor sentiment towards emerging markets have become more and more important, and we believe this will continue to be case in 2019. On Wednesday, September 26th the FOMC announced the third 25bp rate hike of 2018 taking the upper bound of the Fed’s target range up to 2.25%. The accompanying DOT plot revealed that there is now a large majority of members (12-4) calling for a total of four hikes in 2018. We are now expecting a fourth 25bp hike at the December 19th meeting but this is where we part ways with the Fed in terms of our view for future rate hikes. The Fed’s DOT plot shows a median expectation of three hikes in 2019 but we only expect the Fed to move once more next year. In fact, we argue that if the Fed does raise rates three times next year then the US is likely to fall into recession 12-18 months later. The market is implying an end of 2019 policy rate of 2.85% in contrast to the Fed’s median expectation of 3.25%. To our mind, this means that if the Fed does continue along its projected tightening path then the market will reprice US rates higher and we will see another round of stress in the emerging market FX space. 

Second, EM currencies have been bearing the brunt of the protectionist measures launched by the Trump administration as these measures have fuelled concerns about global trade and have weighed on commodity producers. On 24th September, the Trump administration added fuel to the fire by implementing yet another round of tariffs[1] on USD 200bn, raising total US trade measures on China to more than 253bn worth of Chinese imports. Beijing has called off talks to de-escalate the trade tensions and has imposed reciprocal tariffs targeting USD 60bn of US exports to China. In total, China has now retaliated on 113bn of US exports to Chinese shores but in addition it is also targeting the US by raising non-tariff barriers. Going forward, trade tensions between the two largest global economies are likely to continue fuelling EM FX volatility as we highlighted in our report: “New round of US tariffs raises the pressure on China”.

A third determinant which has weighed on some EM currencies has been stubbornly high oil prices which rose from just below USD 65 per barrel in February to more than USD 80 per barrel at the time of writing. Falling supply from Venezuela and sanctions on Iran are starting to feed into higher oil prices. Of course, higher oil prices are supportive for some EM currencies such as COP, RUB and to a lesser extent MXN but high crude oil prices are troublesome for large net oil importers such as South Africa, Indonesia, and especially India and Turkey which imports 90% of its energy needs. In India, crude and refined petroleum alone constitute a whopping 17% of total imports (Figure 2). Higher oil prices result in a deteriorating current account metrics, which lead to further capital outflows and put stress on the currency.

The final major factor driving EM currency weakness has been related to country-specific turmoil. Indeed, domestic developments have been key in driving weakness in Turkey (a move to non-orthodox policies, central bank independence coming into question and high inflation), Brazil (upcoming elections), South Africa (fading optimism that President Ramaphosa will make progress on structural reforms) and Argentina (low reserves, high inflation, lack of confidence). These country-specific events have exacerbated the adverse sentiment of investors towards emerging markets in general as contagion spread to the wider EM FX universe. Countries like Indonesia and India were dragged into global EM turmoil with non-specialist investors taking a broad-based view of asset class. Indeed, the ‘fragile five’ countries[2] that were highlighted during the 2013 ‘taper tantrum’ all found themselves on the back foot.

Rabobank’s Emerging Markets Vulnerability Heatmap

Regular readers are likely to be aware of Rabobank’s FX Vulnerability Heatmap that we first published in the aftermath of the 2013 ‘taper tantrum’ and revisited on numerous occasions since then. Our initial heatmap highlighted Brazil, India, Indonesia, Malaysia and Turkey as our own fragile five before the term garnered attention with South Africa in place of Malaysia. The most vulnerable currencies in our heatmap did change over the years but those currencies always remained close to the most vulnerable end of the spectrum.

Given how well our heatmap has helped us to navigate EM FX weakness over the past five years, we continue to use this as the base of our framework going forward. On these pages, however, we will present our new and improved heatmap. The basic structure is the same as our previous editions but we have reviewed our input variables and split the framework into three main groups: economic variables, debt vulnerability variables and financial market variables.

Methodology: data, variable construction and weighting

In our heat map we benchmark currency fundamentals of 18 emerging market economies for which there was sufficient data available. The sources and frequency of all indicators are shown in Table 1. We assign different weightings to each of these variables depending on their importance for currency vulnerability.

Table 1: Rabobank’s EM Vulnerability Heatmap
Table 1: Rabobank’s EM Vulnerability HeatmapSource: Rabobank, IIF, OECD QNA, IMF Fiscal Monitor, IMF BOPS, OECD MEI, IHS, World Bank, national sources

For example, the current account to GDP ratio is a far more important to currency performance than ‘security risk’ and exposure to foreign denominated debt is more important than household debt for example. This differs from our initial heatmap which had equal weightings but with fewer variables. In our new and improved heatmap we also breakdown our variables into three pillars:

1.         Economic indicators: e.g. the current account deficit (as % of GDP), inflation, competitiveness and political risk

2.         Debt vulnerability indicators: e.g. government and non-financial corporate debt (as % of GDP), debt denominated in foreign currency

3.         Financial market index: e.g. volatility, liquidity and hot money.

So what did we include? (for a list of all variables please see table 2) The economic indicator heatmap gives us an insight into the underlying fundamental strength of each country. Within this we assign higher weightings to the current account deficit, FX reserves import cover, economic growth and political risk, while assigning less relevance to competitiveness and security risk. By way of example, rising political risk and high inflation have played a large role in TRY’s sell-off.

Debt vulnerability is particularly important for currency vulnerability in the current environment as much of the stress seen is being caused by rising US rates and USD strength. In light of this it should come as no surprise that we place a high weighting on foreign denominated debt exposure, both corporate and government, while household debt is not ranked quite as highly as an indicator of currency vulnerability although it is of course important for the underlying health of the economy. Argentina is a special case here given their high exposure to foreign denominated debt, specifically USD denominated government debt. On the other hand other debt levels are fairly low, explaining their relatively good score on this indicator.

Finally, we look at market factors that might impact currency vulnerability. To this end we assess general volatility with the logic being that a currency that is historically more volatile is likely to see larger moves during any sell-off. We also look at a currency’s usual ‘market beta’, or in other words, how vulnerable is the currency to broad-based shifts in market sentiment. If a currency tends to move in line with wider market moves then it is more likely to succumb to contagion should risk sentiment turn. We proxy this by looking at the historical correlation between the currency and global equities as a proxy for general risk appetite. Arguably, the most important factor within the market heatmap is liquidity; an illiquid currency will be more vulnerable to the tides turning than a liquid currency. When EM comes under pressure, investors are quick to try and exit illiquid positions as soon as possible for fear that there will be more slippage on exit as volatility rises. In this respect, a lack of currency liquidity has had an impact on both Argentina and Indonesia.

There is one exception to this rule; while liquidity may be a benefit for most currencies, it can be a disadvantage for Mexico. This is a result of MXN’s unique position within the LatAm region as the only fully deliverable and convertible currency that can be traded 24 hours a day. As a result of this, MXN is often traded as a proxy for the LatAm region as a whole and so can succumb to LatAm stress contagion very rapidly. We should note that MXN is actually the best performing currency in the world so far this year and is the only currency to post gains of more than 1% against USD year-to-date. That said, that factoid disguises the fact that MXN sold off nearly 17% from peak to trough in Q2 in line with broader market stress and exacerbated by uncertainty surrounding NAFTA and the elections. Indeed, the outperformance of MXN has come as broad-based strength has waned and MXN remains the most attractive currency globally from a carry trade perspective and on a risk-adjusted return basis.

Finally, we have added a ‘hot money’ indicator. This measures above-trend portfolio investment inflows into emerging markets. The idea here is that if inflows exceed normal patterns by a substantial amount, then there is increased risk that the same country will face rapid outflows if the sentiment takes a turn for the worse. In other words, hot money inflows leave the country more vulnerable to hot money outflows which can exacerbate currency weakness.


Our heatmap shows Turkey as the most vulnerable country with economic woes and market factors mixing together to produce a potent cocktail of currency vulnerability (figure 3). It will come as little surprise that Argentina obtained a well-deserved second place with substantial foreign-denominated debt, high inflation and poor market factors all playing a role. Of course, the vulnerable nature of both of these currencies has been reflected in their performance with both currencies selling off more than 40% year-to-date.

Figure 3: Turkey is classified as the most vulnerable country, while Argentina comes in second
Figure 3: Turkey is classified as the most vulnerable country, while Argentina comes in secondSource: Rabobank
Figure 4: The fundamentals show that emerging markets in Asia are less vulnerable relative to the other countries
Figure 4: The fundamentals show that emerging markets in Asia are less vulnerable relative to the other countriesSource: Rabobank

A look at vulnerability across regions shows that Latin America is generally the most vulnerable area while Asian currencies look better insulated from broad-based stress.

Figure 5: The heat map is able to explain the currency performance quite well, some countries have been over/underperforming
Figure 5: The heat map is able to explain the currency performance quite well, some countries have been over/underperformingNote: depreciation (against the USD) of each currency is calculated at the current value vis-à-vis the April 2018 value
Source: Rabobank, Macrobond

A look at how our new heatmap rankings compare to currency performance rankings can be seen in figure 5. As can be seen, the chart reveals a relatively tight fit with a few exceptions (such as MXN as we highlighted above). If we look at our z-scores compared to currency returns (figure 5) we see a curve that flattens along both the x and y axis at the extremes. It could be argued that the z-score provides a good indication of the general path of the currency but at the extremes a strong z-score (a less vulnerable backdrop) will still only help so much if there is a broad-based sell off; At the other end of the spectrum, a low z-score (a vulnerable currency) can see a more extreme move than other similarly vulnerable currencies on the back of idiosyncratic domestic factors. For example, TRY sold off further after President Erdoghan suggested he should control monetary policy, and ARS sold off on the back of the perceived panic from the government and central bank as they returned to the IMF early and intervened in the FX market). 

China comes out on top in our heatmap when it comes to a lack of external vulnerability but it is important to view this through a veil of caution. China performs particularly well in the economic pillar given the country’s high growth and low inflation relative to the rest of the countries included. And from a debt perspective, exposure to non-CNY denominated loans is limited which helps China’s score. That said, we must be quick to note that the extreme and rapid build-up in domestic debt is very worrying and should China resort to monetizing said debt then currency weakness would ensue. On the flipside, high reserves helps the PBOC control the exchange rate in the short run.


Rabo’s first EM Vulnerability Heatmap provided a framework that helped us successfully navigate the relative performance of EM currencies during bouts of broad-based weakness on the basis of external vulnerability. Our ‘new and improved’ heatmap should help carry that baton going forward. Of course, domestic issues and events will play a huge role that can, and will, lead to substantial outperformance or underperformance relative to that implied by our heatmap but this framework should provide a good starting point to assess likely baseline performance.

The underperformance of EM so far this year is unlikely to turn around substantially without a significant pullback in USD. Whether or not that is forthcoming remains to be seen but we would argue that if the Fed does follow the tightening path currently outlined by the DOT plot, then another round of EM weakness is likely to occur. Furthermore, uncertainty regarding global trade tensions remain a dark cloud over emerging market countries and the sky is unlikely to clear up anytime soon.


[1] The tariffs of 10% in the 200bn package will take effect on 24 September and from 1 January the tariffs will rise to 25%.

[2] The fragile five highlighted in 2013 were Brazil, Indonesia, India, South Africa and Turkey.


Table 2: Description of variables and data sources
Table 2: Description of variables and data sourcesNote: NFC stands for non-financial corporate debt
Source: Rabobank, Macrobond
Christian Lawrence
Rabobank KEO
Koen Verbruggen
RaboResearch Global Economics & Markets Rabobank KEO
Hugo Erken
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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