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Why Some Emerging Markets Are Suddenly Melting

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bloomberg.com/news/articles/2018-05-29/why-some-emerging-markets-are-suddenly-melting-down-quicktake

Netty Idayu Ismail

Investors had been enamored with emerging markets for more than two years. These days,
they’re not so besotted. For several weeks, money has poured out of developing nations
and into the U.S., causing the dollar to rise in value and the currencies of emerging markets
to hit new lows. Turkey has been at the center of the rout, but many other countries,
including Argentina, Hungary and Indonesia, have been hit as investors dump riskier stocks
and bonds for the safety of U.S. assets. For some economists, it raises the specter of the
late 1990s-era Asian economic crisis. What’s going on?

1. Why are emerging markets suffering?


The easy answer is that money is fickle and opportunistic -- it goes where it can get the
highest return, flowing out of countries as fast as it flows in. This latest upheaval started
when the U.S., Japan and Europe kept interest rates close to, or below, zero to help their
stagnant economies recover from the 2008 financial crisis. That made returns on stocks
and bonds unattractive, and drove investors to developing nations, where the risks were
higher but the payoffs more inviting. Emerging markets, as a result, have enjoyed a rally in
stocks, bonds and currencies. But the reverse is now happening as investors react to
several signals from the U.S. -- faster growth, rising interest rates and a stronger dollar. All
three indicate potentially higher returns on U.S. investments and thus act as a magnet for
money. They also undermine the attraction of riskier emerging markets. The turmoil in
Turkey has especially rattled investors.

2. How scary can this get?


Some say this is just a market hiccup as speculative investors betting on a weaker dollar
were caught off guard by the U.S. currency’s new strength. Others say the developing world
is in worse shape than many investors think. Harvard professor Carmen Reinhart, for
example, has said mounting debt loads, trade battles, rising interest rates and stalled
growth have made emerging markets more vulnerable than on the eve of the 2008 financial
crisis. Paul Krugman, the Nobel Prize-winning economist, has said the current episode
somewhat resembles the Asian financial crisis of the late 1990s, when the MSCI Emerging
Markets Index for developing-nation stocks slid as much as 59 percent.

3. What caused the Asia crisis?


It started when a real-estate bubble burst in Thailand, which undermined confidence in the
economy, causing foreign investors to sell the currency and withdraw from the stock
market. The crisis spread to the banks, and then across much of East Asia. Many of the
afflicted economies had strong growth records that masked weaknesses like
nonperforming bank loans, heavy foreign borrowing and rising trade deficits. Because their

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currencies were pegged to the dollar, South Korea and other nations were forced to spend
billions trying to fend off speculators who were selling their currencies. They soon ran out
of dollars and had to give up the peg and devalue their currencies. The contagion spread
when foreign investors pulled back from other countries in the region seen as having similar
problems. Several ended up seeking bailouts from the International Monetary Fund.

4. So is this another Asian-like crisis?


No, at least not yet. One reason: Investors are selectively punishing markets where policy
makers haven’t done enough to stem deteriorating trade balances and ballooning inflation.
These include Turkey and Argentina, which have the worst combination of weak
governance and high dollar debt among 18 major emerging-market economies. Brazil and
Indonesia aren’t far behind.

5. Who else looks vulnerable?


Economies dependent on dollars and other foreign currencies to finance their trade deficits
-- the Philippines, India and Indonesia stand out -- have the worst-performing currencies in
Asia this year. Those with the highest rates of foreign ownership of government bonds
could be the most vulnerable to capital outflows, including South Africa, Indonesia and
Russia.

6. Why is Turkey in so much trouble?


It’s been one of the hardest-hit emerging-market currencies, shedding more than 17
percent of its value against the dollar this year. Turkey has a large budget shortfall and one
of the biggest trade deficits in the G-20 group of nations. And though Turkey’s inflation rate
is more than 10 percent, its central bank was prevented from raising interest rates by
President Recep Tayyip Erdogan, who is seeking re-election in June and says he prefers
low interest rates, based on his own ideas about monetary policy. He has also said he
plans to take more control over monetary policy if he wins. Last week, the central bank took
emergency steps to arrest the slide with an interest-rate hike to prop up the lira, and
followed this week with a simplification of its interest-rate regime. All of this has made
Turkey seem more risky to investors.

7. Why did so many countries borrow in dollars?


Encouraged by near-zero interest rates after the global financial crisis, developing nations
loaded up on what was then cheap debt. Selling bonds denominated in dollars rather than
the local currency also attracted investors who favored the more stable greenback.
Turkey’s corporate sector, for example, has foreign currency debt in dollars, equivalent to
40 percent of gross domestic output. Global investors, though, sometimes ignored danger
signs, such as rising trade deficits and government spending sprees. They also brushed
aside, until now, the fact that a stronger dollar would make it harder for emerging markets
to repay their debt. That’s because once they borrowed in dollars, they needed to buy
dollars to repay the debt. As the dollar rises in value against the local currency, it costs
more to obtain those dollars.

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The Reference Shelf
A QuickTake explainer on Turkey’s vulnerability.
How some of the key emerging-market indicators have evolved since 2008.
Emerging-market companies and governments straining to deal with the rising cost
of borrowing in dollars face increasing pressure as a record slew of bonds come due.
Investors are punishing markets where policy makers haven’t done enough to stem
deteriorating current-account balances, ballooning inflation and a run on their
currencies.
The Institute of International Finance lowered its forecasts for portfolio flows to
emerging markets after investor appetite for debt tapered off significantly.
Should emerging markets worry about U.S. monetary policy announcements?

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