Note the not-pretty pattern. The flow of funds out of emerging markets has reached the high-water mark of the period leading into the Asian, then Russian financial crises of 1997-1998. However, after recovering from the damage of this period, emerging markets as a whole enjoyed a period of strong growth. In theory, their economies are bigger, and by virtue of running currencies pegged to the dollar, many also have large foreign exchange surpluses, which will enable them to defend their currencies (a fall in currency prices is a nasty outcome, since they often have foreign currency denominated debts).
Nevertheless, focusing on averages obscures where pain is acute. Vietnam, India, Korea and Russia a all are looking more than a tad wobbly, with their currencies under pressure. Although the Chinese stock market has taken a nosedive, the country has exhibited significant inflows of hot money looking to benefit from a yuan revaluation.
From the Financial Times
Outflows from emerging markets bond and equity funds reached $29.5bn over the past three months, the highest level since at least 1995, with withdrawals gathering pace over the past week.
Investors headed for the exits as rising fears over slowing world growth and the state of the banking system over the past week added pressure on emerging markets – which were already reeling from weaker commodity prices, inflationary pressures, a stronger dollar and geopolitical concerns.
Investors switched $1bn out of equity and fixed income funds on Monday, one of the highest daily outflows since records began in 1995, said EPFR Global, the data provider. Last week there were outflows of $1.6bn, bringing the total since June 4 to $29.5bn, the largest three-month figure since 1995.
Nick Chamie, head of emerging markets research at RBC Capital Markets, said: “Since July, investors have finally become aware of the severity of the global slowdown. The emerging markets are a leveraged play on global growth, so in a serious downturn, investors will naturally sell them.”….
The benchmark MSCI emerging market index fell 1.27 per cent to 857.44, the lowest level since March 2007. The fall extended its decline to 4.8 per cent over the past week and 22 per cent over past three months.
The hardest hit stock markets in dollar terms are Ukraine, which has fallen 58.8 per cent this year in part on geopolitical worries; China, down 57 per cent amid fears it had risen too far on a bubble; Hungary, down 49 per cent on worries over growth; Pakistan, down 46.7 per cent amid political turmoil; and Vietnam, down 46.4 per cent in the face of a sharp rise in inflation.
Russia been under pressure, with the benchmark RTS index down 4.4 per cent yesterday and 46 per cent since its May 19 peak.
Emerging market sovereign bond yield spreads have risen to 330 basis points over Treasuries – highs not seen since mid-2005 – from 300bp at the start of last week amid rising risk aversion.
Bonds of the four Bric countries – Brazil, Russia, India and China – have also been hit by rising interest rates this year.
Update 1:00 AM: Brad Setser has a post on the very same subject, but focusing on the implications for currency values. Some key statements:
Joanna Slater of the Wall Street Journal notes that many countries that were resisting pressure for upward appreciation are now selling dollars to defend their currencies. I very much agree with the quote from Lisa Scott-Smith:
….As investors retreat from places they used to favor, many of them emerging markets, it creates a new worry for central banks in these countries.
When too much capital was flowing in, their main problem was that such flows put upward pressure on their currencies. A stronger currency makes exports more expensive abroad, harming trade competitiveness. To curb currency appreciation, central banks would buy dollars, and that led to a large accumulation of reserves.
Now “that is unraveling the other way,” says Lisa Scott-Smith of Millennium Global Investments, a London currency manager with $13 billion in assets. With investors unloading local stock and bond holdings, central banks find themselves “on the other side of the trade, trying to smooth currency weakness instead of strength.”
Read it here.
This is the same effect that Michael Pettis described in his book “The Volatility Machine,” except that it is not stemming from central bank behavior, but overall global economic growth. They are at the tail in this game of crack-the-whip.
I guess it will go down till dollar devaluation come on the radar screens. That will come up only if domestic consumption in EM gains traction. Then you will see dollar depreciation on the horizon.
Then EM will be up and up – till actually dollar depreciates fully.
Then again it will be downhill bumps as US gains traction and starts looking attractive.
Expect a lot of trade related diplomacy as EMs try to corner their citizens as drivers of domestic demand and impose on other countries to corner their citizen as drivers of export demand. Lot of policy paper will change hands for sure.
US must flip from being a consumer to being a producer. ROW must stop being just a supplier to US – when consumer goes supplier goes with them!
Thats the game in a nutshell. Unless I am missing something.