Emerging Markets Turmoil: Tempest In A Teapot?

Capital Outflows | The meltdown in China’s stock market this summer and steep falls in many emerging markets currencies led some investors to wonder if another 1997 Asian crisis was brewing.

However, analysts and economists who focus on emerging markets say conditions are completely different from those of the late 1990s.

“The obsession with an emerging markets crisis is bordering on the compulsive,” says Jan Dehn, head of research at investment manager Ashmore. “Most EM countries now have very sizable domestic institutional investor bases that own most of the assets. As such, foreign outflows simply do not destabilize EM economies as much as in the past.”

Total capital outflows from EMs increased in August to their highest level since the global financial crisis, says William Jackson, senior emerging markets economist at Capital Economics in London. “This was overwhelmingly due to flows out of China,” he says. “By contrast, in spite of the gloomy headlines, there is no evidence of a flood of capital departing the rest of the emerging world.”

Capital flows are important in many EMs because they help to finance spending and can influence capital market performance, Jackson says. Because official data is published with a considerable time lag, Capital Economics has developed its own Capital Flows Trackers in an effort to monitor flows on a timely basis.

In the three months through August, nearly $250 billion flowed out of EMs, Capital Economics estimates. “If we strip out our estimate of capital outflows from China, it looks like total net capital flows to the rest of the emerging world were slightly positive,” Jackson says. What’s more, portfolio inflows to EM countries were highly positive in the same period.

Dehn of Ashmore says that instead of worrying about the potential impact of Federal Reserve rate hikes on EMs, investors should worry more about such developed markets issues as low growth, falling productivity, lack of investment, financial markets that are propped up by hot air (from quantitative easing), major medium-term debt issues and a lack of reform.

EM countries now account for 57% of global GDP on a purchasing-power-parity basis, but only about 20% of total debt and credit, according to Ashmore.

“Yet, EM crises continue to be an easy sell with investors, despite the enormous improvements in EM’s economic fundamentals over the past couple of decades,” Dehn says. “Ask 100 randomly chosen people, and the odds are that 99 of them will still tell you that EMs are a collection of fragile tin-pot dictatorships whose economic survival hinges on commodity prices and unrealistic funding from overseas speculators.”

Few investors paid attention to China’s stock market rally, Dehn says, and even fewer predicted a major surge in China’s GDP growth as a result. But after China’s stock market bubble burst in June, “the airwaves are replete with dire predictions about yet another Chinese hard landing,” he says

Kent Kedl, managing director for China and North Asia at consultants Control Risk, says that if there is a real cause for concern, it is the challenge that market volatility could pose to China’s political leaders, who have been touting the safety of the market and encouraging investment in it for more than a year.