Sell Emerging-Market Currencies on Rally, Morgan Stanley Says

By Patricia Lui

Oct. 31 (Bloomberg) -- The recovery in emerging-market currencies is temporary and investors should sell on rallies and hedge against further weakness, according to Stephen Jen, Morgan Stanley's global head of currency research.

Interest-rate reductions by central banks around the world, liquidity injections and currency swap facilities may not be enough to ward off a global recession, Jen said in a research note yesterday. Seven of the 10 most-active Asian currencies outside Japan strengthened against the dollar this week, with South Korea's won leading the rally with an 11.3 percent gain. The MSCI Asia-Pacific Index of stocks rose 7.5 percent, erasing almost all of last week's losses.

``We remain very worried about emerging-market currencies,'' Jen wrote in his report. ``Global fundamentals will continue to overwhelm country fundamentals and will be most emerging-market unfriendly as the world falls into a deep recession.''

Dollar shortage among local corporations, falling capital inflows into emerging countries and investors' ``re-examining'' the prospects of economic growth will push the currencies weaker, he said.

In the past month, Iceland, Hungary, Belarus, Pakistan and Ukraine have approached the International Monetary Fund for financial assistance. The U.S. Federal Reserve also announced up to $120 billion in currency swap facilities for Mexico, Singapore, South Korea and Brazil this week to ensure sufficient dollar liquidity. Central banks in the U.S., China, Hong Kong and Taiwan lowered benchmark interest rates this week.

`Marginal Support'

``The IMF's latest facility and the Fed swap lines will provide marginal support for selected emerging-market currencies but will not be enough to fully offset the powerful forces of a global recession pushing emerging currencies lower from here,'' Jen said.

Most of the countries have large foreign-exchange reserves and the IMF program and the Fed's swap lines are not ``game changers,'' he said.

``The irony is that most of the countries targeted already have very large'' reserves, Jen wrote. ``The question is why they haven't been able or willing to resist currency weakness with so much reserves.''

IMF programs also rarely signal a turning point in currencies, the note said.

During the 1997-98 Asian financial crisis, South Korea, Thailand, Indonesia and the Philippines sought IMF help as speculators bet against their currencies, triggering an exodus of funds that almost wiped out their foreign-exchange reserves.

Jen didn't provide forecasts for currencies.

To contact the reporter on this story: Patricia Lui in Singapore at plui4@bloomberg.net