Doesn't the world market decide currency values? Yes and no. Major currencies such as the U.S. dollar, the Euro, and the Japanese Yen are free-floating currencies where the market does determine their value. Governmental policies may affect a currency's value, but it does so through the market's reaction to those policies.
By contrast, so-called pegged currencies tie the value of the currency to a standard — usually the dollar or the Euro — by establishing a standard exchange rate. In some cases, the currency is tied to a "basket" of currencies. These countries control trade by applying capital controls on the amount of money that can be converted, or by allowing trading within a pre-determined tolerance around the pegged value.
Currency pegs provide stability and predictability for the most part, but can cause great chaos when they are moved, especially without warning. China's recent move to devalue their currency, the yuan, sent shock waves through global markets as investors worldwide leaped to the conclusion that the Chinese economy was weaker than expected.
By devaluing their currency, the Chinese government instantly made their exported goods cheaper, and left their trading partners with a dilemma: adjust their currency as well, or face a potential trade imbalance. Vietnam has already devalued its currency, the dong, in response.
Oil-dependent economies and their trade partners face similar problems. With an oil surplus, the Russian ruble has dropped significantly and Russia's trading partners now face currency pressures. Pegged currencies are dependent on another country's financial situation and policies, leaving central banks with few tools to deal with internal goals that may not match the reference country's actions.
Buying foreign currency reserves and cutting interest rates can only go so far, and sometimes countries are left with no choice but to either let the peg slip through devaluation or abandon it altogether and let the market apply some painful fiscal medicine. Kazakhstan recently did so and absorbed a 22% devaluation of its currency, the tenge.
Other pegged currencies are in precarious positions right now, given the combined effect of the strength of the dollar, low oil prices, an eventual rise in U.S. interest rates, and a worldwide economic slowdown that is harming exports. Either the currency has been dragged to a value beyond what the country's economy can support, or the adjustments of trading partners threaten to dampen the economy by harming exports. In some cases, both stressors apply.
Bloomberg recently identified ten currencies that are in trouble, based on forward contracts — positions predicting future currency moves.
- Saudi Arabian Riyal – Saudi Arabia has plenty of foreign currency reserves to hold on and drive out less efficient oil-producing methods (primarily U.S. shale), but with Iran joining the party soon, it remains to be seen how long the Saudis can hold out.
- Turkmenistan Manat – An oil-exporting nation, Turkmenistan has already devalued its currency by 19% and the forward contracts suggest a similar devaluation to come.
- Tajikistani Somoni – The markets expect a similar drop to that of its close trading partner Kazakhstan.
- Armenian Dram – With Russia accounting for 25% of its trade, Armenia has watched its dram slide alongside the ruble, although not as dramatically (15% compared to 46% for the ruble).
- Egyptian Pound – Some capital controls have been in effect since the uprising in 2011, and stability remains elusive. A currency drop of greater than 20% is indicated by the forward contracts.
- Turkish Lira – Chinese devaluation and unrest within Turkey and in the neighboring nations have hit the lira hard. Forward markets are expecting the fall to continue.
- Nigerian Naira – Oil prices make the efforts to keep a high currency value difficult. Speculators are betting Nigeria will fall to the tune of a 20% devaluation.
- Ghanaian Cedi – Oil, debt, inflation, and poor fiscal policies make the cedi a likely candidate for devaluation.
- Zambian Kwacha – Fallen Chinese demand for copper combined with the devalued yuan puts Zambia in a difficult position. Copper accounts for nearly 70% of the country's exports.
- Malaysian Ringgit – The ringgit hit its lowest value since 1998 and currency reserves are slipping below benchmark levels.
The common threads: oil and a deep connection to Russia and/or China. It is hard to see any of those currency stressors improving in the short-term, thus the Bloomberg analysis is likely spot on.