Recent months have been marked by a major focus on the
supposed decline in asset prices from the so-called ‘BRIC economies’ of Brazil,
Russia, India and China economies, as well as emerging markets (EMs). Some
suggest that the issue could be as big and far reaching as the 1997 Asian
In hindsight, such fears are clearly unfounded,
but it should be noted that they are not without basis. There were indeed
alarming moments a few months ago when foreign investments were exiting BRICs
and EMs on a large scale, resulting in depressed asset prices and even weaker
domestic currencies for these countries – the exact problem faced by Southeast
Asian economies in 1997.
Comparing then and now, there are even more
similarities beyond an outflow of funds. Firstly, emerging economies have fared
extremely well in the past five years as a result of investors exiting the
eurozone and America due to the subprime mortgage crisis. This is similar to
how hot money flows pushed EM assets higher in the 1990s, when investing in
Asia was all the rage.
The fiscal soundness of EM countries remains
an issue, with Thailand’s current account swinging between surplus and deficit
on a month-to-month basis, and with Indonesia and India deeply in the red. It
seems that in more than 15 years, EMs have not truly learned their lesson.
American Political Gridlock a Lifesaver
Besides these two major similarities, the event that drove money out of the
EMs appears to be the same as well. The US dollar (USD) and American stocks
have, once again, regained their lustre after years of underperformance. The
S&P 500 index has outperformed most , if not all global stock indices with
the USD strengthening following talk of the Federal Reserve possibly ending its
quantitative easing programme, which has depressed the USD and weighed on
interest rates heavily. This scenario is almost identical to the 1997 crisis,
when the US was recovering from a recession in the early 1990s.
With these major similarities, it is hard to mock those who were expecting a
rerun of 1997. Instead, we should be asking, “why haven’t the same ingredients
resulted in a similar crisis this time around?”
explanation would be that the outflow of funds from EMs into the US has been
stymied by the dramas surrounding the US debt ceiling and last month’s
temporary government shutdown in Washington DC. The threat of a potential US
default has become so daunting that investors are rethinking whether America
can be considered a better investment haven compared with that currently on
offer from the EMs. Even though the debt-ceiling issue has been partially
resolved (or rather, the can has been kicked further down the road), there is
no guarantee that American lawmakers will be able to put aside their
differences and come to an amicable solution early next year. It is no wonder
that investors, who were previously interested in the US, may be getting cold
feet right now.
This change of attitude could turn out to be a
lifesaver for many EM economies. With the stoppage of foreign funds leakage, EM
currencies have stabilised, and asset prices have regained their previous path
of appreciation. From a year-to-date perspective, most Asian stock indices
(barring Chinese bourses) remain firmly in the black, suggesting that the
decline in the second and third quarters was not truly substantial. It could
act as confirmation that the bullish trend of EM assets remains intact.
Emerging Markets Have Limited Time to Act
That said the fiscal soundness – or lack thereof – of EMs remains suspect,
while the total factor productivity of these countries remain the same as
before. In some instances, such as Singapore and China, it has actually
decreased. As American economist Paul Krugman once noted, growth in asset
prices due to increase in capital investment alone is not sustainable, and one
should seriously consider the implications should the US manage to resolve its
internal issues once and for all – or at least until president Barack Obama
ends his term in January 2017.
Hopefully, this temporary lifeline
afforded to EMs will be put to good use, and will allow the respective
governments to enact financial reforms and increase productivity per capita.
China is pulling no punches in this regard. India and Indonesia have embarked
on similar paths of reform. As investors are forward-looking, we do not need to
see huge improvements from now until the time when the US resolves its issues.
As long as there are signs of improvements, it is likely that investors will be
willing to keep their faith in EM assets, or at the very least, keep their
hands away from the eject button.
Bank of Japan (BoJ) stimulus may
be another factor that can help EMs buy time. For better or worse (from a BoJ
perspective), a large portion of the 132 trillion yen (JPY) package –
equivalent to US$1.4 trillion – will flow into EMs. This will help to keep
these countries’ assets afloat on top of the temporary stopping of leakage into
the US. However, it also means that inflation and the risks of asset bubbling
will increase, and EMs will need to address productivity issues quickly to
prevent the same situation rolling over in a few years’ time.
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