The biggest brokerage and investment bank in Japan, Nomura Holdings, has issued a warning that seven nations, including Egypt, Romania, Sri Lanka, Turkey, the Czech Republic, Pakistan, and Hungary, are now at high risk of experiencing currency crisis.
According to Reuters, the Japanese bank reported that 22 of the 32 nations covered by its internal “Damocles” warning system had witnessed an increase in risk since its last update in May, with the Czech Republic and Brazil experiencing the biggest rises.
It indicates that since May, the total of the model’s scores for all 32 grew significantly from 1,744 to 2,234 points.
“This is the highest total score since July 1999 and not too far from the peak of 2,692 during the height of the Asian crisis,” Nomura economists said, calling it “an ominous warning sign of the growing broad-based risk in EM currencies”.
The model computes an overall score based on eight important variables, including a nation’s foreign currency reserves, exchange rate, financial soundness, and interest rates.
Nomura calculates that a score above 100 implies a 64 per cent likelihood of a currency crisis in the next 12 months based on data from 61 prior EM currency crises that have occurred since 1996.
Egypt currently has the lowest score at 165 after devaluing its currency significantly twice already this year and applying for an IMF programme.
Romania, which has been using interventions to support its currency, is listed next on page 145. Both Turkey and Sri Lanka, which frequently has currency crises due to default, have ratings of 138, while the Czech Republic, Pakistan, and Hungary receive scores of 126, 120, and 100, respectively.
The Damocles model was also applied by Nomura to the G7 group of advanced countries. The results showed that all but Japan now had Damocles scores over the 100-point barrier, with the United States and Britain leading the way.
EM economies continue to be increasingly fragile. Due to their incomplete recovery from the COVID-19 epidemic, the majority of countries are currently dealing with high inflation, a finite amount of fiscal room, negative real interest rates, a weakened balance of payments, and reduced FX reserve cover.
“It is somewhat surprising that there have not been more full-blown EM currency crises this year,” Nomura added.
“Then again, EM challenges are far from over… The late Professor Rudiger Dornbusch once said, A crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought”.
