Emerging market currencies are the currencies of the countries that have relatively low income per capita, but high potential for economic growth and development. Emerging market currencies include the Brazilian real, the Russian ruble, the Indian rupee, the Chinese yuan, and many others. Investing in emerging market currencies can offer attractive returns and diversification benefits for investors, but it also involves significant risks and challenges. In this article, we will explore the risks and opportunities of investing in emerging market currencies, and how to manage them effectively.
The Opportunities of Investing in Emerging Market Currencies
Investing in emerging market currencies can provide several opportunities for investors, such as:
- Higher returns. Emerging market currencies can offer higher returns than developed market currencies, as they can benefit from the faster economic growth, the higher interest rates, and the stronger demand of the emerging markets. For example, according to Nasdaq, the MSCI Emerging Markets Currency Index, which tracks the performance of 25 emerging market currencies, has gained 9.4% in 2021, outperforming the MSCI World Currency Index, which tracks the performance of 10 developed market currencies, which has gained 2.6% in the same period.
- Lower correlation. Emerging market currencies can offer lower correlation with developed market currencies, as they are influenced by different factors, such as domestic policies, regional dynamics, and global events. For example, according to Bloomberg, the correlation between the MSCI Emerging Markets Currency Index and the MSCI World Currency Index was 0.54 in 2021, indicating a moderate positive relationship, but not a perfect one. This means that emerging market currencies can diversify a portfolio of developed market currencies, and reduce the overall risk and volatility of the portfolio.
- Higher potential. Emerging market currencies can offer higher potential for appreciation, as they can benefit from the structural reforms, the technological innovation, and the demographic changes of the emerging markets. For example, according to Investopedia, some of the factors that can boost the value of emerging market currencies are the improvement of governance and institutions, the adoption of digital and green technologies, and the growth of the middle class and the consumer market.
The Risks of Investing in Emerging Market Currencies
Investing in emerging market currencies can also involve significant risks for investors, such as:
- Higher volatility. Emerging market currencies can experience higher volatility than developed market currencies, as they are subject to various shocks and uncertainties, such as political instability, social unrest, economic crises, and external pressures. For example, according to Emerald Insight, some of the factors that can cause large fluctuations in emerging market currencies are the changes in government policies, the conflicts and tensions in the region, the shifts in market sentiment, and the spillovers from the major economies.
- Higher costs. Emerging market currencies can incur higher costs than developed market currencies, as they are less liquid and more regulated than the latter. For example, according to Bloomberg, some of the costs that investors have to pay when investing in emerging market currencies are the bid-ask spreads, the transaction fees, the taxes, and the capital controls. These costs can reduce the net returns and the efficiency of investing in emerging market currencies.
- Higher complexity. Emerging market currencies can pose higher complexity than developed market currencies, as they require more research and analysis to understand and evaluate their performance and potential. For example, according to Investopedia, some of the challenges that investors face when investing in emerging market currencies are the lack of reliable and timely data, the diversity and heterogeneity of the markets, and the unpredictability and variability of the outcomes.
What are some examples of emerging market currencies?
The Brazilian real (BRL), which is the official currency of Brazil and ranks as the 20th most traded currency globaly, It was introduced in 1994 as part of a plan to stabilize and grow the Brazilian economy after a period of hyperinflation. Brazil exports large amounts of commodities, agricultural products, and manufactured goods and will have a nominal GDP of $1.49 trillion in 2021.
The Russian ruble (RUB), which is the official currency of Russia and ranks as the 16th most traded currency globally, It is one of the oldest currencies in the world, dating back to the 13th century. Russia is a major producer and exporter of oil, gas, metals, and weapons and will have a nominal GDP of $1.71 trillion in 2021.
The Indian rupee (INR), is the official currency of India and ranks as the 15th most traded currency globally. It is derived from the Sanskrit word rupya, meaning silver. India is a fast-growing and diverse economy, with a large service sector, a strong IT industry, and a huge consumer market. It has a nominal GDP of $3.05 trillion in 2021.
The Chinese renminbi (CNH), is the official currency of China and ranks as the 8th most traded currency globally. It is also known as the yuan, which is the unit of account. China is the world’s second-largest economy and the largest exporter of goods, with a dominant role in manufacturing, technology, and trade. It has a nominal GDP of $16.64 trillion in 2021.
The South African rand (ZAR), is the official currency of South Africa and ranks as the 18th most traded currency globally. It is named after the Witwatersrand, a ridge of gold-bearing rocks in the country. South Africa is a major producer and exporter of gold, platinum, diamonds, and other minerals, and has a diverse and developed economy. It has a nominal GDP of $0.32 trillion in 2021.
How to Manage the Risks and Opportunities of Investing in Emerging Market Currencies
To manage the risks and opportunities of investing in emerging market currencies, investors need to adopt some strategies and practices, such as:
- Align with the goals and risk tolerance. Investors need to align their investment in emerging market currencies with their financial goals and risk tolerance, as different emerging market currencies have different levels of return and risk, and different degrees of correlation and diversification. Investors need to determine their desired level of exposure to emerging market currencies, based on their expected return, risk appetite, time horizon, and liquidity needs, and adjust their portfolio allocation accordingly.
- Balance between return and risk. Investors need to balance between return and risk when investing in emerging market currencies, as higher returns usually come with higher risks, and lower risks usually come with lower returns. Investors need to weigh the potential benefits and costs of investing in emerging market currencies, and consider the trade-offs and the scenarios of different currency movements. Investors also need to diversify their portfolio across different emerging market currencies, to reduce the concentration and the volatility of their portfolio, and to enhance the stability and the resilience of their portfolio.
- Monitor and review regularly. Investors need to monitor and review their investment in emerging market currencies regularly, as the currency markets and the exchange rates are constantly changing and evolving, and can be influenced by various factors, such as economic fundamentals, political events, market sentiment, and global developments. Investors need to keep track of the performance and the value of their portfolio, and compare it with their goals and expectations. Investors also need to update their portfolio allocation, and make any necessary changes or adjustments, to reflect the changes in the currency markets and their personal circumstances.
Conclusion
Emerging market currencies are the currencies of the countries that have relatively low income per capita, but high potential for economic growth and development. Investing in emerging market currencies can offer attractive returns and diversification benefits for investors, but it also involves significant risks and challenges. Investors need to understand the risks and opportunities of investing in emerging market currencies, and adopt appropriate strategies and policies to manage them effectively. By doing so, investors can optimize their portfolio performance and achieve their financial goals.