Another Asian Crisis? We Don't Believe So‏

In recent weeks, turmoil in Emerging Markets has accelerated with stock markets and currencies plummeting in a number of countries including Indonesia, India, Thailand and Turkey.

The flight of capital stems from a cocktail of adverse factors:

1. Fed tapering is becoming real. Investors are increasingly leaving countries with big current account deficits that have a greater reliance on external financing and liquidity. Turkey for example has a current account deficit of close to 10% of GDP and both India and Indonesia have seen rising imbalances over recent years.

2. Growth disappointments. Emerging Markets have disappointed badly in terms of delivering growth over recent years. Coming out of the financial crisis it was widely agreed that companies and investors should look to Emerging Markets for growth. Hence capital flew to these economies both in terms of direct investment and portfolio investments. Performance in EM has disappointed badly though and money has started to flow out of these markets and this capital outflow has accelerated over the past few months.

3. Policy responses. In times of financial turmoil, trust and good leadership becomes a key factor. Unfortunately what we have seen so far is bad leadership which is affecting trust among investors and has led to further capital flight. For example India has introduced small-scale capital restrictions. They are too small to have any real effect in stopping the flows. But they are big enough for investors to fear more capital restrictions coming – hence investors try to get out before that happens. In Turkey the central bank announced it would intervene in the currency market to stabilise the currency. This could very well prove counterproductive though – see Flash Comment – Turkey: TRY inching closer to fair value.

4. Contagion. Finally, as is normal in financial turmoil, contagion is a factor. Hence countries that don’t necessarily ‘deserve’ to be sold are still getting hit because investors drop everything that just smells of EM risk. The decline in Thailand is partly a result of this as Thailand’s fundamentals are not that bad.

An underlying reason for the growth disappointments in Emerging Markets is the weak development in developed economies over the past three years. As private consumption and investment has slowed substantially in the West, the ‘factories of the world’ and the suppliers of commodities for production of these goods have suffered as well.

However, as demand growth rises slowly but surely in developed markets, growth should start to improve in Emerging Markets as well. When that happens, money should start to flow back again.

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