Frail EMs, brace for more strife


Tensions in Ukraine, currency volatility in China, political risk in Thailand and Turkey –these incidents threaten to deal frail emerging markets another blow, say analysts.

"The big picture right now is that risks are varied enough but there is a chance of them pervading other emerging markets, so it's time for investors to stay on dry land for a bit," said Vishnu Varathan, a market economist at Mizuho Corporate Bank. "It's a case of trepidation rather than terror."

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Worries about a debt default in Ukraine and growing tensions between the West and Russia over Ukraine's future following the ousting of President Viktor Yanukovych at the weekend have fueled risk aversion in global markets.

(Read more: Risk of a bank run heightens in Ukraine)

The yield on 10-year Treasurys hit a three-week low of 2.66 percent overnight, while the U.S. dollar index rose to its highest level in about two weeks as jittery investors sought out safe-havens.

Russia on Wednesday ordered a drill to test the combat readiness of its armed forces, fueling investor jitters over Ukraine and helping send the Russian rouble to a five-year low at about 36.06 per dollar.

Risk aversion

In addition, the Turkish lira fell 0.8 percent overnight to a three-week low of 2.2530 per dollar as pressure mounted on Prime Minister Tayyip Erdogan to step down amid a corruption scandal that has embroiled the government.

"We are seeing risk aversion in general resurface," said Nizam Idris, managing director, head of strategy, fixed income and currencies at Macquarie Bank. "The tension in Ukraine is one reason for this – Ukraine's debt is largely funded by Russia, so if Ukraine defaults then Russia bears the brunt."

Brazil's central bank meanwhile hiked its key interest rate by 25 basis points to 10.75 percent on Wednesday, breaking a streak of six straight 50-basis-point hikes. Still, the move highlighted that emerging markets continue to see a need take action to prop up weak economies, analysts said.

(Read more: Brazil slows interest rate hikes to shield weak economy)

The root cause of EM's inflation problem is...

"Brazil hiked its key rate by 25 basis points, as we expected…which is also EM [emerging market] currency negative," Dariusz Kowalczyk, senior economist at Credit Agricole, said in a note.

The China factor

Analysts add that what began as a sell-off in emerging markets last year related to fears about an unwinding of U.S. monetary stimulus has broadened out to political risks and worries about the outlook for China's economy.

(Read more: Is China getting ready to widen the yuan's band?)

Increased volatility in the Chinese yuan this week has fuelled talk that Beijing is getting ready to widen the currency's trading band, infusing an element of uncertainty regarding the world's second biggest economy.

The yuan strengthened to about 6.1231 per dollar on Thursday, holding above a seven-month low hit the previous day.

"China FX uncertainty alongside potential property-market cooling and related credit tightening has a tendency to spillover as broader EM Asia risks," said Varathan at Mizuho. "EM uncertainties prevail. From Pandora's Box-type of risks involving "unknown unknowns" to Jack-in-the-Box risks that just blindside markets. Buckle Up"

Writing by CNBC's Dhara Ranasinghe. Follow her on Twitter at @DharaCNBC