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Cash Flow Out Of Emerging Markets

Worldwide money flows are of interest to a long term investor and the flight out of emerging markets has been striking.  Weren't emerging markets supposed to where our expansion was to take place?  What now?

According to the IIF, the volatile market conditions have taken a toll on capital flows to emerging markets, with net non-resident portfolio flows in August falling into negative territory for the first time in 2015, according to the Institute of International Finance’s latest EM Portfolio Flows Tracker. Outflows were estimated at $4.5 billion in August compared to inflows of $6.7 billion in July.

“Portfolio flows to emerging markets have retreated sharply in the last few weeks,” said Charles Collyns, chief economist at the IIF. “Emerging market investors have been spooked by rising uncertainty about China, and stress has been exacerbated by a combination of fundamental concerns about EM economic prospects and volatility in global financial markets.”

Emerging market equity flows fell to their lowest level since the 2013 taper tantrum at -$8.7 billion, while debt flows were estimated to have softened but remained positive at $4.2 billion in August. 

The IIF also issued a Flows Alert, highlighting a marked intensification of the retrenchment in EM portfolio flows in recent days. The alert was triggered on Monday, August 24. That day alone, the seven emerging markets that provide daily flows data experienced outflows of $2.7 billion, the same magnitude as on September 17, 2008 during the week of the Lehman Brothers bankruptcy.

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Is The Emerging Market Boom Over?

During the last few years, a lot of hype has been heaped on the Brics (Brazil, Russia, India, China, and South Africa). With their large populations and rapid growth, these countries, so the argument goes, will soon become some of the largest economies in the world – and, in the case of China, the largest of all by as early as 2020. But the Brics, as well as many other emerging-market economies – have recently experienced a sharp economic slowdown. So, is the honeymoon over?

Brazil's GDP grew by only 1% last year, and may not grow by more than 2% this year, with its potential growth barely above 3%. Russia's economy may grow by barely 2% this year, with potential growth also at around 3%, despite oil prices being around $100 a barrel. India had a couple of years of strong growth recently (11.2% in 2010 and 7.7% in 2011) but slowed to 4% in 2012. China's economy grew by 10% a year for the last three decades, but slowed to 7.8% last year and risks a hard landing. And South Africa grew by only 2.5% last year and may not grow faster than 2% this year.

So, what is ailing the Brics and other emerging markets?

First, most emerging-market economies were overheating in 2010-2011, with growth above potential and inflation rising and exceeding targets. Many of them thus tightened monetary policy in 2011, with consequences for growth in 2012 that have carried over into this year.

Second, the idea that emerging-market economies could fully decouple from economic weakness in advanced economies was far-fetched: recession in the eurozone, near-recession in the United Kingdom and Japan in 2011-2012, and slow economic growth in the United States were always likely to affect emerging-market performance negatively – via trade, financial links, and investor confidence. For example, the ongoing eurozone downturn has hurt Turkey and emerging-market economies in Central and Eastern Europe, owing to trade links.

Third, most Brics and a few other emerging markets have moved toward a variant of state capitalism. This implies a slowdown in reforms that increase the private sector's productivity and economic share, together with a greater economic role for state-owned enterprises (and for state-owned banks in the allocation of credit and savings), as well as resource nationalism, trade protectionism, import-substitution industrialisation policies, and imposition of capital controls.

This approach may have worked at earlier stages of development and when the global financial crisis caused private spending to fall; but it is now distorting economic activity and depressing potential growth. Indeed, China's slowdown reflects an economic model that is, as former Premier Wen Jiabao put it, "unstable, unbalanced, unco-ordinated, and unsustainable," and that now is adversely affecting growth in emerging Asia and in commodity-exporting emerging markets from Asia to Latin America and Africa. The risk that China will experience a hard landing in the next two years may further hurt many emerging economies.

Fourth, the commodity super-cycle that helped Brazil, Russia, South Africa, and many other commodity-exporting emerging markets may be over. Indeed, a boom would be difficult to sustain, given China's slowdown, higher investment in energy-saving technologies, less emphasis on capital- and resource-oriented growth models around the world, and the delayed increase in supply that high prices induced.

The fifth, and most recent, factor is the US Federal Reserve's signals that it might end its policy of quantitative easing earlier than expected, and its hints of an eventual exit from zero interest rates, both of which have caused turbulence in emerging economies' financial markets. Even before the Fed's signals, emerging-market equities and commodities had underperformed this year, owing to China's slowdown. Since then, emerging-market currencies and fixed-income securities (government and corporate bonds) have taken a hit. The era of cheap or zero-interest money that led to a wall of liquidity chasing high yields and assets – equities, bonds, currencies, and commodities – in emerging markets is drawing to a close.

Finally, while many emerging-market economies tend to run current-account surpluses, a growing number of them – including Turkey, South Africa, Brazil, and India – are running deficits. And these deficits are now being financed in riskier ways: more debt than equity; more short-term debt than long-term debt; more foreign-currency debt than local-currency debt; and more financing from fickle cross-border interbank flows.

These countries share other weaknesses as well: excessive fiscal deficits, above-target inflation, and stability risk (reflected not only in the recent political turmoil in Brazil and Turkey, but also in South Africa's labour strife and India's political and electoral uncertainties). The need to finance the external deficit and to avoid excessive depreciation (and even higher inflation) calls for raising policy rates or keeping them on hold at high levels. But monetary tightening would weaken already-slow growth. Thus, emerging economies with large twin deficits and other macroeconomic fragilities may experience further downward pressure on their financial markets and growth rates.

These factors explain why growth in most Brics and many other emerging markets has slowed sharply. Some factors are cyclical, but others – state capitalism, the risk of a hard landing in China, the end of the commodity super-cycle – are more structural. Thus, many emerging markets' growth rates in the next decade may be lower than in the last – as may the outsize returns that investors realised from these economies' financial assets (currencies, equities, bonds, and commodities).

Of course, some of the better-managed emerging-market economies will continue to experience rapid growth and asset outperformance. But many of the Brics, along with some other emerging economies, may hit a thick wall, with growth and financial markets taking a serious beating.

Originally posted @ http://m.guardiannews.com/business/2013/jul/23/emerging-market-boom-over-nouriel-roubini

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