Emerging Economies problems reflect scarcity of US$

The crisis in emerging economies has moved off the front pages but not gone. The Summer rout was largely shrugged off by investors in the West; institutional investors rebalanced out of emerging markets, but currency markets took most of the pressure. A rebound in China and Brazil has convinced many the growth fears were misplaced. Yet China’s renewed easing is likely to prove temporary, as shadow banking concerns resurface. In other nations, such as India, interest rates are rising to defend currencies and cool domestic bubbles.

Despite the delay in the Fed’s taper, competition for the supply of  US Dollars worldwide constraints growth.  Investors should not underestimate the risks to global growth. The coming months will see companies warn of problems in what were thought to be fast growing markets. emerging economies’ growth forecasts will be revised down and investors should be prepared for a rebalancing of global growth in favour of the US and Europe.

Money printing in the West has helped restore confidence and lift stockmarkets. Consumer confidence is recovering in the UK and Europe, with a further recession averted. But much of the printed money has flown into the wrong areas; house prices in London are up 7% over the past 12 months. Some of the money has flown into emerging markets, in a search for growth and stability, creating a property bubble across Asia. The avalanche of newly printed money led to a broad emerging market boom, sucking in private and institutional investors alike. Over the past 10 years, emerging markets have materially outperformed the global averages. But, the long term record of emerging markets shows recurring economic crises and greater volatility. Investors may have forgotten the Asian financial crisis of 1997, and misunderstand the risks.

The flow of Western capital into emerging economies has typically forced imbalances in current accounts. A number of economies have lost competitiveness; with fading productivity gains, over-priced currency and property, and excessive inflation. India is a prime example, and has been one of the worst hit in the current crisis. Now it has been joined by many others; Indonesia, Philippines, Malaysia, Brazil, South Africa and Turkey. Investors are hit as currencies fall, and stockmarkets collapse.

The responses to this by the countries involved will have consequences for Western investors. India and Indonesia have set import controls that will hit sales of some luxury goods, such as cars. Others have raised interest rates to defend their currency, which will cool their economies and possibly burst the worst excesses in the property bubble. The supposed huge reserves of foreign currency have dwindled rapidly in countries that have attempted to defend an over-valued currency.

More likely these currencies will simply be allowed to settle down to a level at which competitiveness returns. This will devalue the earnings that Western companies, such as Unilever, get from their emerging market exposure. It may seem like a short term, contained, crisis, but has the potential to hit Western companies. And, the higher oil price will further cut global growth and squeeze availability of Dollars globally.

To date, the outflows from emerging markets have largely been from institutional investors. But, private investors are likely to follow, particularly if any of the problem countries ultimately appeal to the International Monetary Fund for support. So far, there is little guidance from most of the investment managers of emerging markets funds.

Reports from these funds have attempted to comfort investors. Yet, whilst most say that the falls mean the emerging markets now offer good value, it is hard to see where any net buying will come from. Many emerging markets funds are already fully invested or may need some liquidity for redemptions. Most have viewed their focus on emerging markets as an act of faith. Indeed, the same countries have been in some portfolios for a quarter century, suggesting markets that are taking a long time to emerge. And, the supposedly strong sovereign balance sheets of emerging economies and their foreign exchange reserves may be questioned. Many still have high levels of state involvement in commerce, and little transparency.

Investors are likely now to focus on more domestically-oriented UK businesses. The Pound may have risks, but it looks a haven of stability compared with some recent emerging economy currencies. There are worse places to be than invested in some of the larger consumer-oriented businesses in the UK and Europe.

This article was published in The Herald on 28th September 2013

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