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Emergingmarkets:ThegreatunravellingFT.com

April1,20157:27pm

Emergingmarkets:Thegreatunravelling
JamesKyngeandJonathanWheatley

Developingeconomiesaresufferingtheirbiggestcapitaloutflows
sincethefinancialcrisis

acedwithrecession,decadehighinflation,afiscalcrisisandwaterrationing,more
than1mBrazilianstooktothestreetslastmonthtoprotestagainstcorruptionand
mismanagementintheirgovernment.InChina,growthisslowingaspropertypricesfall,
propellingmorethan1,000ironoreminestowardfinancialcollapse.Thepatrioticcitizens
ofRussia,meanwhile,aredesertingtheirnationsbanks,switchingsavingsintoUSdollars.
Suchsnapshotsofgrowingdistressintheworldslargestemergingmarketsareechoed
amongmanyoftheirsmallercounterparts.SeveralcountriesinSubSaharanAfricaare
besetbydwindlingrevenuesandrisingdebts.Eventheturbopoweredpetroeconomiesof
theGulf,hitbyahalvinginthepriceofoiloverthepastsixmonthsto$55abarrel,are
movingintoaslowerlane.
Thoughtheseexpressionsofdistressderivefromdisparate
sources,onebigandinsidioustrendisworkingtoforgeacommondestinyforalmostall
emergingmarkets.
Thegushofglobalcapitalthatflowedintotheireconomiesinthesixyearssincethe2008
09financialcrisisisinmostcountriesnoweitherslowingtoatrickleorreversingcourseto
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findasaferhomebackindevelopedeconomies.
Highestoutflowssince2009
Onanaggregatebasis,the15largestemergingeconomiesexperiencedtheirbiggestabsolute
capitaloutflowsincethecrisisinthesecondhalfoflastyear,asastrongUSdollardrove
emergingmarketcurrenciesintoaswoonandinvestorsgrewnervousovertheprospectofa
tighteninginUSmonetarypolicy,accordingtodatacompiledbyING.Atthesametime,low
commoditypricesslammedGDPgrowthratesacrossthedevelopingworld.
Thesetrends,analystssay,signalagreatunravellingofanemergingmarketsdebtbinge
thathasswollentounprecedenteddimensions.Importantly,thepaininflictedbythiscapital
flightisbeingfeltbeyondfinancialmarketsintherealeconomiesofvulnerablecountries
andinasurgingnumberofemergingmarketcorporationsthatareforecasttodefaulton
theirdebts.
Certainpartsoftheworldarelookingreallyvulnerable,saysMaartenJanBakkum,senior
emergingmarketstrategistatINGInvestmentManagement.PlaceslikeBrazil,Russia,
ColombiaandMalaysia,thatrelyheavilyoncommodityexports,aregoingtogethiteven
harder,whilethosecountriesthathaveborrowedmostexcessivelylikeThailand,Chinaand
Turkeyalsolookrisky.

Analystssaythatwhileemergingmarketshavebeenthesettingforseveralrecentfinancial
squalls,thecurrentexodusofcapitalcouldheraldmorefundamentalchanges.Indeed,
althoughthetapertantrumofmid2013triggeredbytheUSFederalReservesignalling
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itsintentiontounwinditsmonetarystimuluscausedturmoilinfinancialmarkets,its
impactonrealemergingmarketeconomieswastransitory.
Thistimearound,though,thingslookmoreserious.TheInternationalMonetaryFundsaid
thisweekthattotalforeigncurrencyreservesheldbyemergingmarketsin2014akey
indicatorofcapitalflowssufferedtheirfirstannualdeclinesincerecordsbeganin1995.
Withoutsteadycapitalinflows,emergingmarketcountrieshavelessmoneytopaytheir
debts,financetheirdeficitsandspendoninfrastructureandcorporateexpansion.
Realeconomicgrowthissettosufferthisyear,analystssay.CapitalEconomicsexpectsGDP
growthinemergingmarketstofallto4percentfrom4.5percentin2014,asRussiaslips
deeperintorecession,BrazilcontinuestostruggleandChinaishamperedbyitsailing
propertymarket.

Underlyingsuchsoberprojectionsisasensethataninflectionpointhasbeenreachedwith
theendofthecommoditysupercycleandtheadventoflowoilprices.Whatisgoingonis
agreatunravellingofthemarketconditionsofthepast15years,saysPaulHodgesof
InternationaleChem,achemicalsandcommoditiesconsultancy.
MrBakkumalsoseesasignificantreversalintheanimatingforcesofglobalcapitalism.The
EMcapitaloutflowsrepresentthegradualunwindingoftheexcessiveinflowsintothe
emergingworldduringtheyearsofzerointerestratesintheUS,hesays.
However,theoutlookisnotuniversallybad.InvestorshaveflockedtoIndia,whichhasa
reformmindedgovernmentandhasgainedfromfallingenergypricesthathavehelpedit
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slashitscurrentaccountdeficit.IndonesiaandMexicoarealsoattractinginvestmentfor
similarreasons.
Foreignexchangeslump
Nevertheless,accordingtodatacollatedbyINGfortheleading15emergingmarket
economies,netcapitaloutflowsinthesecondhalfoflastyeartotalled$392.4bn.This
comparedtoatotalof$545.9bnincapitaloutflowsoverthreequartersduringthe200809
crisis.Ifthefirstquarterofthisyearalsoshowsacapitaloutflow,thetotallossfrom
emergingmarketsoverthreequarterscouldgetclosetothatseenduringthecrisis.Itis
possible,analystssay,thatoutflowswillnotonlycontinueinthefirstquarterofthisyearbut
mayactuallyacceleratetoeclipsethe$250.2bnseeninthefinalthreemonthsof2014.

Whilein200809theUSwasakeycatalystofemergingmarketdistress,thistimeChinais
seenasthechiefbugbear.SlowingChineseGDPgrowth,coupledwithaslowdownin
construction,istriggeringalargeboutofcapitalflightasinvestorsthinktheywillearnmore
byparkingtheirmoneyelsewhere.
ThemainexpressionofthisreversalistheimplosionoftheChinacarrytrade,inwhich
ChineseinvestorsborrowedatlowratesofinterestabroadtopumpbackintoChinese
propertyandarangeofshadowyfinancialproducts.Butsuchinvestmentsnowseemmore
risky,andarecord$91bnfledthecountryinthefinalquarteroflastyear.
ItsallChina,directlyandindirectly,saysFredericNeumann,economistatHSBC.
Despiteasolidcurrentaccountsurplus,capitaloutflowsoverthepastsixmonthshave
drainedreservesfromChinasvastforexchest...andwiththerenminbimorefairlyvalued
todayitisdifficulttoseeChinarunningbigbalanceofpaymentsurplusesagain.
InBrazil,fragilitystemsfromacombinationoffallingcommoditypricesandtherisingUS
dollar.Althoughthecountrymanagedtoattractnetcapitalinflowsinthesecondhalfoflast
year,thecostofdoingsowasapunitiveinterestrateenvironmentinwhichthepolicy
lendingrateis12.75percent.
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Payingdebts
Likemanyemergingmarkets,criticssay,Brazilfailedtouseitsboomyearstomakethe
toughdecisionsneededtodriveproductivitygrowth.Toreformwhileyouarefacing
headwindsisverydifficult,saysSergioTrigoPaz,headofEMdebtatBlackRock.Some
emergingmarketswillstruggletokeeptheirinvestmentgraderatings.
AccordingtoastudybyMcKinsey,totalemergingmarketdebtroseto$49tnattheendof
2013,accountingfor47percentofthegrowthinglobaldebtsince2007.Thatismorethan
twiceitsshareofdebtgrowthbetween2000and2007.

Someofthemostsignificantcapitaloutflowsareoriginatingfromcountriesthatpileddebts
upthequickest.SouthKorea,forinstance,sawitsdebttoGDPratioriseby45percentage
pointsbetween2007and2013,whileChina,Malaysia,ThailandandTaiwanexperienced
debtsurgesof83,49,43,and16percentagepointsrespectively.
Butitisnotonlycountriesthatarevulnerable.Anotherareaofconcernistheriseofthe
emergingmarketcorporatehardcurrencybondmarket.Tenyearsago,ithardlyexisted.
Today,itisestimatedatmorethan$2tn,makingitbiggerthanthe$1.6tnUShighyield
bondmarket,anassetclassfamiliartoinvestorsfordecades.Itsgrowthwasfuelledby
expansionarymonetarypoliciesintheUSandelsewhereandbythehuntforyieldamong
investorsandfundmanagerswithtargetsthatcouldnolongerbemetindevelopedmarkets.
ButUSpolicyischangingcourse.DavidSpegel,headofemergingmarketbondstrategyat
BNPParibas,isamongthoseexpectingconditionsforemergingmarketborrowersto
deteriorate.Inarecentreport,HarbingersofDefault,heunderlinedthedangersposedby
capitaloutflows:Thepersistenthighercostoffundingwillcontinuetoerodecreditquality
forrelatedhigherriskissuers,ifsustained...Sincemostdefaultstypicallycoincidewith
significantinvestoroutflows,wecontinuetobelievethatfurtherboutsofEMdistressmay
yetcometobearonthemarket,asforcedsellingisexacerbatedbyalreadylowliquidity
conditions.
Indeed,MrSpegelnotes,currentbondpricessuggestinvestorsexpecttherateofdefaultfor
noninvestmentgradeEMbondsaboutathirdofthetotaltorisefrom2.8percenton
Wednesdayto12percentinJanuary2017.
Iftheupshotofallthisismerelythatcountriesandcompaniesthathaveengorged
themselvesirresponsiblyondebtaresettoreceiveadoseofmarketdiscipline,thenallwell
andgood.Thedangerforemergingmarkets,andthewiderworld,isthatthecapitaloutflows
willsnowballtoanextentthatrobsEMcountriesofthelifebloodtheyrequiretocreatejobs
andengendertheirpeoplewithhopeforthefuture.
RELATEDTOPICS United States of America, China, Brazil economy, South Korea Business & Finance
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