Countries such as Hungary, lacking the protection of high interest rates, may take the hit from the next selloff wave in emerging markets now bold rate hikes have made the likes of Turkey too costly to bet against.
Calm appeared to have returned to emerging markets over the past week after concerns about a slowing Chinese economy and a US stimulus wind-down sent fast money investors fleeing and whipped up near-panic selling of currencies.
Abrupt rate hikes in Brazil, India, Turkey and South Africa last month and last year's tightening in Indonesia - the "Fragile Five" economies with high external capital needs - have helped alleviate pressure on currencies.
While the same problems that pressured the markets in the first place - high inflation and current account deficits - are still there, rising interest rates make it simply too expensive for foreign investors to sell their currencies.
Now investors are testing the resolve of countries like Hungary, Russia and Romania, whose current account positions are less problematic.
The concern there is rather that the central banks are either more tolerant of currency falls than other countries or planning to cut interest rates, thereby not offering investors enough reward for the risks.
"Fragile Five is the story that is done," said Daniel Wood, senior fund manager of emerging markets debt at BNP Paribas Investment Partners.
"Investors are broadening out the attacks. It's now expensive to attack Brazil, Turkey and South Africa. They're looking beyond the Fragile Five because it's getting expensive to short them with interest rate hikes."
Wood is short Romanian leu and Hungarian forint against long Turkish lira and Colombian peso.
Turkey's benchmark policy rate - its one-week repo rate - now stands at 10 percent. This compares with Romania's benchmark rates of 3.5 percent and Hungary's 2.85 percent.
"We're short leu in the forward spaces. It's not expensive. The leu could ultimately come under attack if they continue to provide cheap liquidity," he said.
The Russian rouble is another currency that has been under pressure, even though the economy has a current account surplus - estimated to be 1.6 percent of gross output last year - with over half a trillion dollars in foreign exchange reserves.
Benchmark rates are also at a high 6.6 percent. However, the central bank's reluctance to raise interest rates in the face of higher inflation is eroding the rouble's yield advantage and leading to capital flight.
The rouble has lost over 5 percent so far this year against the dollar and has hit record lows on a dollar-euro basket. The central bank conducts interventions if the rouble strays outside of the band, but it has also said it will stick to its plan to free-float the rouble by next year.
Barclays Capital says hiking policy rates is seen as the measure of the last resort.
This is triggering a huge capital exit. According to EPFR, USD 1.6 billion of funds have left Russia since the start of January.
Even after aggressive central bank tightening by the Fragile Five, interest rates adjusted for inflation are still at rock-bottom levels - deterring local buyers.
Deutsche Bank says real policy rates across emerging markets have averaged just 1.1 percent since 2009, which compares with an average of 3.4 in 2008.
That suggests the pain is far from over.
"Monetary policies are far from 'tight' and there has been little evidence that policymakers are willing to tighten fiscal policy where needed to facilitate the adjustment," said Henrik Gullberg, Deutsche's strategist.
"Unless policies are rebalanced to contain domestic absorption, EM currencies will continue to bear the brunt of the adjustment."
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
