Emerging Currencies Challenge Forex Status Quo

Emerging Currencies Challenge Forex Status Quo

The foreign exchange market, most commonly the Forex market (Foreign Exchange Market) is the largest market in the world and one of the highest liquidity. The forex market is dominated by seven currencies that are traded the most, and the positions they occupy are rather steadfast. The top rungs of the forex structure admit of brief excursions, but as compared to the volatility that riddles currencies that are found below hierarchically. The recent years have seen a substantial shift in the secondary currencies, coming to play a considerable role in the global turnover. This change principally affected seven emerging markets, some of them being quite easy to guess, others not so much. However, to get a full picture of what is happening on the large foreign exchange scale, one should get familiar with the status quo that has been maintained for years.

Foreign Exchange Trading Volume Increases Globally

Based on the report of the Bank for International Settlements’ (BIS) of three-year turnover at the forex published in April 2013, the forex activity hovered around $5.3 trillion of daily revenue during those four weeks. The values had gone up 33 percent from the same month in 2010 reported at $4 trillion and signalling a quaternary increase in global turnover since 2001, from slightly more than $1.2 trillion. BIS surveys are perhaps the most solid source for information on forex.

And notwithstanding the fact that the forex turnover has diminished by approximately $300 since the last BIS survey that is now estimated at a total of $5 trillion, the growth of global forex turnover is registered at 25 percent since four years. The follow-up of the April 2013 BIS report mentioned above saw the increase in trading activity at forex market associated with the major expectations of benefits from yen monitory policy.

Currency Subordination at FX

BIS 2013 survey highlights that the U.S. dollar tops the list of major forex currencies, though minor fluctuations occur now and then. Its average daily share in all forex transactions reached 87 percent. (It should be noted that as a pair of currencies is involved in every transaction, percentage share per individual currency is taken for 200, not 100.)

Other major forex currencies are euro, Japanese yen and British pound, holding the shares of 33.4 percent, 23.0 percent and 11.8 percent respectively. The change in monitory policy in the Japanese yen zone made JPY rise 63 percent since 2013. The four major currencies has held their positions firmly since 2000 with brief and minor excursions.

In 2013 the BIS survey reported the Australian dollar, Swiss franc and Canadian dollar to hold the position down one rung of the hierarchy ladder from the four major currencies. Their correlation is not something set in stone, for instance, the Australian dollar went up and down, holding the seventh position in the yearly turnover ranking in 2001, but surging to the fifth in 2013.

Breakthrough Currencies in Forex

The BRIC zone provides four of the seven secondary currencies of Forex; BRIC zone consists of the leading emerging economies: the Brazilian real, Russian ruble, Indian rupee and Chinese renminbi (also called yuan). The remaining three positions are distributed between other currencies from the EMEs (emerging economies) zone: the Mexican peso, Turkish lira and South African rand. Those currencies have experienced an increase in daily average turnover collective share of 4.6 percent between 2010 and 2013. (Remember that when we speak about individual currency shares summed up we mean 200 percent.)

The Mexican Peso, Chinese remninbi and Russian ruble surged in forex trading to a considerable extent, climbing 171 percent for the Mexican peso and registered and $135 billion in 2013. The currency individual share augmented to 2.5 percent of the total forex activity and making it to be the eighth-most traded currencies. But for the Chinese remninbi the increase percent was even bigger, amounting to 250 percent rise since 2010 ($120 billion in 2013) and landing the currency with the ninth position among most actively traded currencies. The Russian ruble surged 140 percent and shifted position from number 16 to the twelfth position in 2013.

But as the emerging currencies surge, the major currencies have to give way; euro, Swiss franc and Canadian dollar have all experienced a slowdown in growth since 2010. Thus, euro daily turnover climbed as little as 15 percent to roughly $1.8 trillion. The tumble of euro can be explained by the debt crises in which the EU has found itself by 2010. By 2013 euro declined 6 percent to 33.4 percent of daily turnover in 2013, however, maintaining its position of the world’s second-most traded currency.

Factors For EME Growth

What makes the second-tier currencies of the emerging economies so very attractive is their high annual percentage. Thus, a Brazil 10-year government bond gives yields 11.18 percent, and the rates are 8.71 percent and 8.04 percent of yearly differentials for India and South Africa, respectively. To better understand the nature of their success with experienced investors, compare those with the interest rates of a U.S. 10-year government bond of 2.55%. As you can see, margin account holders are not the only reason for the increased trading activity among EME currencies.

The nature of these currencies, however, is somewhat specific. Morgan Stanley (MS) analysts singled out five counties with emerging economies to form the so-called “Fragile Five”: Brazil, Indonesia, India, South Africa and Turkey offer high interest rates, but their economies are most often riddled with a lot of complexities such as national debt and uncontrollable inflation. Those nations saw an abrupt trough in the value of their currencies, since the deficit of current-account and budget coupled with an average inflation rate of 7.5 had brought a decline in growth of foreign investing between 2013 and 2014, caused also by more rigid monetary policy of the U.S.

As BIS analysts see it, the increase of the forex turnover between 2010 and 2013 has not been driven by the changes by numerical forex strategies. A lot of central banks loosened their monetary policy promoted the decline in interest rates, the cramped trading area for the majority of the most-traded currencies and unexpected policies caused by harsh times; all of this made the timing bad for quantitative strategies in forex. Take for example the measures taken by the European Central Bank during the Eurozone crisis. Those factors conditioned considerable drainage in quantitative currency hedge funds that diminished by almost $25 billion between 2008 and 2013 to mere $10 billion.

What Makes Forex Turnover Surge?

BIS sees there exist three main reasons for a sharp increase of the forex turnover in the secondary currencies of nations with emerging economies.

The surge of EME currencies has been driven by increased sales of forex derivatives over-the-counter (OTC), namely, currency swaps, forwards and options. The turnover percentage value of OTC derivatives climbed 41 percent between 2010 and 2013, rising from $380 billion to $535 billion by contrast to rise of 17 percent for forex exchange spot turnover. This is the main reason to believe that risk-averse orders by investors with foreign portfolio contribute the most to the rapid turnover growth in forex.

Emerging currencies are getting internationalized; the main driver for this is offshore buying and selling, which is trading in currencies outside of their countries issuing them. Such portfolios increased by 35 percent the EMEs currencies growth out of 41 percent. The most effectively traded offshore currencies are remninbi and rupee, both coming from Asia-Pacific. Asia-Pacific zone is getting increasingly dominated by the Chinese rimninbi, contributing the most to the offshore portfolio trading activity. The growth of remninbi in offshore trading is depicted in its $86 billion turnover per day, or 72 percent of global forex turnover.

EME currencies follow a trend of the so called financialization. The fact observed by BIS is that with the exponential growth in forex turnover for emerging economics, the movement of financial assets for the corresponding country also increases. Take for example Asian countries with the increase in their cross-border financing portfolio equalling 10 percent, and surging of Asian currencies in forex turnover by 7 percent; for Latin America countries this value is 3 percentage points bigger. One should keep in mind though that the surge of forex turnover is not backed up by the adequate growth of national economies. This pattern has been followed for years and years, and this is what the analysts now refer to as financialization, which is not expected to change any time soon.

You can see in the table given below how much a difference is between GDP and forex turnover, with the revenue from currency trading exceeding GDP for every EME listed. If we take 250 working days a year for calculation basis, yearly forex turnover vs. GDP ratio value will be found between 3.6 for Chinese economy and 39 for that of South Africa. Compare these values to a forex turnover related to GDP average ratio of 63 for the seven major currencies. Taking all of the above in consideration, it is safe to assume that the situation is not likely to change for these seven currencies any time soon.


An important thing to consider is the exponential growth of the emerging economies to which the seven most-traded currencies belong, and they are becoming increasingly important. Top this with the hedging and speculative demand coupled, tendencies to internationalize and financialize currencies in question, and we have a forecast of a still bigger increase in their share of global forex turnover in the nearest future.

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