“Investors sometimes have to pay a short-term price for the high long-term rewards from emerging markets,” says Jenny Lowe on FTAdviser.com. T
he Morgan Stanley Capital International (MSCI) Emerging Markets Index, up for seven of the past nine years, has lost 22% in 2011. MSCI indices tracking Latin America, Asia ex-Japan and Eastern Europe are down 20%-24%. The MSCI BRIC index (covering emerging market heavyweights Brazil, Russia, India and China) has fallen by 26%.
The Brics have crumbled
“Bric trouble is the norm rather than the exception these days”, says The Economist. Earlier this year, efforts to rein in inflation dampened growth. India’s “loss of momentum on reform” hasn’t helped. As for China, “problems that once preoccupied the cynical fringe – [the] property bubble and potential for social unrest – have quickly become consensus concerns”, says Kopin Tan in Barron’s.
More recently, the euro crisis, which has sent the continent into recession, has damaged growth. China’s exports to the EU, its biggest trading partner, are expected to turn negative on an annual basis next month. “Foreign investors have been fleeing,” says FxPro.com. This is reflected in the 20% fall of India’s rupee against the US dollar since the end of July.
As global risk aversion rises, capital quits risky assets (such as emerging stockmarkets), damaging growth further. Brazil, as we noted a fortnight ago, is especially reliant on foreign capital, so its departure helps explain why growth fell below zero in the third quarter.
Weaker commodity markets have also hampered Brazil. Russia’s rapid recent capital outflows, stoked by civil unrest, “are threatening a liquidity squeeze in the banking sector”, says Capital Economics.
Eastern Europe in big trouble
All the headwinds buffeting the Brics apply, in varying degrees, to emerging markets in general. A particular problem when it comes to capital outflows is Europe’s banks retrenching. More than $2trn of assets is likely to be shed over the next year to meet new capital requirements, says Humayun Shahryar of Auvest Capital Management.
That bodes ill for eastern Europe, where exports to the eurozone comprise a hefty 35% of GDP in Hungary and the Czech Republic. Eurozone banks account for almost half of overall credit in emerging Europe, says Capital Economics – compared to 2.3% in emerging Asia and 17.1% in Latin America.
The key danger is western European banks limiting short-term funding to their eastern subsidiaries. Interbank lending of this kind is worth almost 15% of GDP in Croatia and Hungary. The region is “sliding… into recession”.
Asia will slow
The latest turbulence shows that decoupling is impossible, says Mike Riddell on Bondvigilantes.com. “Asia is, after all, an export-driven cyclical economy as a whole.”
Note too, says Bank of America Merrill Lynch, that “European banks have a large presence in trade financing, and disruptions could hurt Asian trade volumes and growth significantly”. At least a “healthy balance sheet” gives Asia more room than other regions to temper the downturn.
As we head into 2012, emerging-market growth estimates are being cut back and the extent of the slowdown remains hard to gauge – not least because a possible collapse of the eurozone would wreak havoc globally. So even though emerging markets are trading at reasonable valuations, global investors seem unlikely to regain their appetite for risk soon.