The Wall Street Journal-20080128-Investors May Continue Emerging-Market Retreat

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Investors May Continue Emerging-Market Retreat

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Emerging markets likely will remain out of favor as risk aversion remains high, threatening to trigger policy shifts as those countries move to shore up their currencies.

The appetite for risk in high-yielding emerging markets was damped last week when the Federal Reserve's surprise decision to slash interest rates three-quarters of a point raised concern about the global economy.

"Currency weakness will likely be more centered on emerging-market European currencies as current-account deficits dwarf those in other emerging-market regions," said Lawrence Goodman, a currency strategist with Bank of America in New York.

At the top of the list of European currencies deemed vulnerable are the Polish zloty, Hungarian forint and Romanian leu. Other currencies at risk are the Turkish lira, South African rand and Icelandic krona, analysts say.

Polish policy makers are worried they can no longer rely on an appreciating zloty to curb inflation. "If the exchange rate doesn't return in coming weeks to [an appreciating] trend or if volatility increases, then our current policy dilemmas will intensify," central- bank board member Andrzej Wojtyna wrote in the daily Rzeczpospolita that appeared Friday.

Right now, the currency has proved resilient, bouncing back to mid- December levels after an initial fall of 5% against the dollar and 1.5% against the euro between Jan. 13 and 21.

But Polish central bankers worry about growth-damping prospects of a U.S. recession, throwing in doubt expectations Poland could tighten rates by as much as a point this year.

Romania's leu has slipped 5% against the euro so far this year, even though the National Bank of Romania raised rates to 8% from 7.5% and has signaled another increase Feb. 4. Gov. Mugur Isarescu said he preferred the leu at last summer's level of around 3.30 to the euro, more than 10% higher than the current level.

Durmus Ylmaz, the governor of Turkey's central bank, believes he might have to lower his benchmark rate of 15.5% more slowly on concerns of flight by foreign portfolio investors. The lira spiked down to 1.22 against the dollar last Monday, but has since come back to the 1.17 level of the beginning of the year.

"It is clear that the appetite for emerging markets has declined," said Elisabeth Gruie, an emerging-market currency strategist with BNP Paribas in London.