London - Emerging markets risk is shattering into “BIITS”. Investors in these markets are becoming more discerning about where they put their money, shying away from countries such as Brazil, India, Indonesia, Turkey and South Africa.
Behind the discrimination is a new-found focus on current account deficits and structural weaknesses exposed by the likelihood of less stimulus from the US Federal Reserve and cooling demand in China, according to economists from HSBC, JPMorgan Chase and International Strategy & Investment Group (ISI).
That is a break from the past four years, when emerging markets mainly moved in tandem, seen as either a blanket buy or sell, with little regard to individual circumstances. Such a mindset was epitomised by the popularity of the Bric acronym coined for Brazil, Russia, India and China to reflect their potential as future economic powerhouses.
“Investors will be far more choosy among emerging markets than they’ve been in the past,” said Donald Straszheim, the head of China research at New York-based ISI. “There will be a natural inclination to seek out the ones that are the best positioned.”
Mexico, the Czech Republic and South Korea are among the still-attractive countries because they are less reliant on foreign finance or took advantage of easy money from Fed stimulus to strengthen their economies.
Fed surprise
The Fed’s surprise decision last month to continue its asset purchases provided emerging markets with a respite, as sales of their currencies abated. The reprieve will be only temporary though, according to Michael Shaoul, the chairman of Marketfield Asset Management.
Some of these nations would see further capital outflows in the next three to six months as investors started to “break it down between good emerging markets and bad emerging markets”, he said. His firm is betting against emerging-market equities and bonds, including those of Brazil and India.
“I don’t think the bear market in emerging markets has bottomed. There is a real selling opportunity.”
The prospect of the Fed reducing its stimulus was a “persistent” external risk, South Korean Finance Minister Hyun Oh-seok said in a speech at a power plant this week.
The theme of differentiation is gaining ground as the International Monetary Fund (IMF) warns that growth in emerging and developing countries is the weakest since 2009. The lender cut its forecast earlier this month to show them expanding 4.5 percent this year, down from a July prediction of 5 percent.
Since the start of May – the month the Fed signalled it might consider paring its $85 billion (R834bn) in monthly bond purchases – the Indonesian rupiah has fallen 11 percent against the dollar and the Indian rupee has declined 12 percent, with the Turkish lira dropping 9 percent and Brazilian real losing 8 percent. By contrast, the Mexican peso has lost 5 percent, the South Korean won has risen 3.8 percent and the Czech koruna has climbed 3.5 percent.
The worst may not be over for the BIITS, if the past is any guide. The Brazilian real lost 51 percent in 2001 and 2002, the Indonesian rupiah plunged 86 percent in 1997 to 1998 and India’s rupee fell 42 percent from 1990 to 1992. In 2000 and 2001, the Turkish lira declined 68 percent and the South African rand depreciated 52 percent.
Many emerging markets had also used up a lot of their defences fighting the global financial crisis in 2008, said Mohamed El-Erian, the chief executive and co-chief investment officer at Pacific Investment Management, the manager of the world’s biggest bond fund.
While Mexico was “doing the right thing”, he said, Brazil was “back to its old habits” and Turkey “denies it has a problem”.
As these differences became more apparent, said Marc Chandler, the New York-based chief currency strategist at Brown Brothers Harriman, people now wanted “to buy the best of breed”.
“The Mexico story is attractive and more compelling than some of the others in the region”, while “the BIITS list might be the more-troubled emerging markets”.
At the same time, F&C Asset Management emerging-market equities head Jeff Chowdhry said, developing economy stocks and currencies might have been oversold and many would be able to recover as investors reacquired a taste for risk.
“The terrible five could do pretty well because they’ll have improvements in the currencies and stock markets,” he said. “From our perspective, we’re finding the most opportunities in those economies, with the exception of South Africa.”
Investors are taking a closer look as the Institute of International Finance (IIF) in Washington predicts that private capital flows into emerging markets will fall by $153bn to $1.1 trillion this year and slide by another $33bn next year.
“The basic story for emerging markets right now is we’re going through an adjustment,” JPMorgan Chase chief economist Bruce Kasman said in an October 11 panel discussion at the IIF. “There were excesses that were created. It’s going to take a while to work this out, and I don’t think we should expect emerging markets to come back to anything like we were used to.”
Turning point
Behind the palpitations are slower growth in China compared with the mid-2000s and signs that US monetary policy may be reaching a turning point, according to HSBC chief economist Stephen King.
Previously, China’s double-digit expansion prompted investors to bet that it would serve as a magnet for the products and commodities of other emerging markets, he said. In addition, low interest rates in developed countries led capital to seek higher returns elsewhere, masking or even encouraging faultlines such as widening current account deficits, weak productivity, a small share of investment relative to domestic consumption and delays in infrastructure improvements.
“After the financial crisis, the magic asset was mostly to be found in emerging markets and money poured in,” King said at the IIF panel discussion. It was “often with no regard to whether the underlying quality of growth in the emerging market world was necessarily good”.
A “return to reality” was now setting in, said Erik Nielsen, the global chief economist at UniCredit in London. The key concern with the BIITS was related to their “reliance on short-term foreign financing, particularly as global trade grows very slowly and we are moving towards some sort of monetary normalisation”.
Brazil has suffered a slump in the real after relying on credit-led consumption, which failed to boost productivity and returned its current account to a deficit of about 3 percent of gross domestic product (GDP).
Indonesia is hampered by inflation close to a four-year high and a record current account shortfall. India is held back by cooling growth, elevated inflation, inadequate infrastructure, and distorted regulations.
Last month, Standard & Poor’s (S&P) reiterated that it might downgrade the country’s credit rating to junk on risks including budget and current account imbalances.
Turkey and South Africa now have current account gaps bigger than 6 percent of GDP. Russia is hobbled by weaker global demand for its exports of oil, natural gas and metals and is growing at the slowest pace since a 2009 contraction.
The Czech Republic, South Korea and Mexico looked better positioned to accommodate Fed-inspired higher interest rates, Goldman Sachs economists said last month. Mexico’s current account shortfall is 1 percent of GDP, and South Korea has a surplus.
S&P maintained its positive outlook for Mexico’s credit ratings this month on the prospect that President Enrique Peña Nieto’s economic programmes will boost growth. He has proposed breaking a 75-year state monopoly on oil drilling, a plan that may unleash a boom in energy production and is attracting foreign investor interest in the country.
More differentiation
“What you will see is a lot more differentiation,” Marco Annunziata, a former IMF official and now chief economist at General Electric, said during the IIF discussion. “What’s important is to distinguish between one emerging market and another.”
European Central Bank board member Jörg Asmussen said: “Some decisions major advanced economies are taking have influence on other countries.” Over the past few months, “the negative spillover effects were strongest in countries with a big current account deficit and a delay in domestic reforms”.
The shake-up is prompting emerging market leaders to urge that countries begin preparing for the Fed’s eventual moves.
“You can’t all have the same monetary policy, but we do need to have a much better conversation and a greater predictability of responses,” Singapore Finance Minister Tharman Shanmugaratnam said.
It’s not all bad news. The Fed’s decision not to taper last month has given emerging markets more space to put their houses in order.
China’s economy accelerated from July to September for the first time in three quarters, and Kasman at JPMorgan noted that a pick-up in growth in the developed economies might help provide an offsetting lift for the rest of the world.
The market fallout after the Fed’s tapering signal in May served as a “stress test” for countries, which now knew “where their weaknesses lie”, Naoyuki Shinohara, a deputy managing director at the IMF, said.
Among those taking heed are Indonesian Finance Minister Chatib Basri, who said this month that he would deepen efforts to boost national productivity. “In bad times, you can start pushing for structural reforms” because there was less political resistance, he said. - Bloomberg