Emerging Markets Under Pressure After Wall Street Crisis

While the main saga plays itself out in New York and London, there has been a significant ripple effect on the rest of the world. Investors in emerging markets like South Africa, which are known as “second tier economies”, have predicted an era of stunted growth and weaker currency.

Overall, emerging markets are already down 33% this year, which is far worse than the performance on Wall Street itself. Concern over Washington’s $700 billion bailout plan played a part in the tumble of the rand on Tuesday by more than 2%. Stock markets in India, Turkey and Russia all fell by more than 3%.

However, there are very few market analysts that predict a return to the financial drama that overwhelmed Asian economies in 1997, as well as Russia, Brazil, Argentina and Turkey in subsequent years. Emerging markets like South Africa are far more robust financially than in the past, with healthy surpluses that have been accumulated for just such a rainy day. There are some that might even attract investors wary of Wall Street and London.

According to Arnab Das, head of emerging markets research at Dresdner Kleinwort, an investment bank in London, “The unfortunate reality is that in one way or another everyone in the world is exposed, but that doesn’t mean there won’t be winners and losers”.

Mark Williams, an analyst of emerging Asian economies at Capital Economics, a London consulting firm, says, “Whenever something like this has happened, risk aversion has always won out and emerging markets tend to suffer more than most when the world gets into trouble”.

The primary factor for concern is that these countries generally run large current account (trade) deficits, which continue to rely on foreign investment to balance the books. South Africa’s deficit is close to 10% of gross domestic product, while in some countries like the Balkans and the Baltics it is even higher.

Royal Bank of Canada’s emerging markets strategist, Nigel Rendell says, “The financial stress leads investors to avoid things that are high risk. Emerging markets can be a high risk and an area to keep out of”. He goes on to say that if investment dries up then these countries could be left short of cash. Consequently, the only option left is to let the currencies slide.

The currency “is either devalued, or allowed to depreciate, or you have to slow down the domestic economy and slow imports from coming in at such a rate,” Rendell says. This could signal a sharp slowdown in growth rates in Turkey and Eastern Europe.

India Leaking Capital

India also seems to have been ‘leaking capital’, which has resulted in a failing currency that has subsequently put upward pressure on inflation, with figures currently more than 12%. “Comparatively, we would say India is relatively insulated because its economy is relatively closed, but we have seen capital leaving India and pressure on the currency,” says Hugo Navarro, an economist at Capital Economics. “It’s to the stage where the government is stepping in and taking steps to strengthen [the rupiah] because of concerns over inflation”.

The more optimistic news is that there are emerging economies like Russia and Brazil that are flush with cash due to peak commodity prices, as well as an economic boom in China. But even these countries are not immune, as leading Shanghai stocks are down more than 60% from their peak. The Russian market was suspended for 2 days last week having fallen more than 50% over the past four months.

It has been noted by Williams that emerging Asian stocks have dropped by more than those in developed countries, but this does not mean that the region suffers from the same financial imbalances as those affecting Western finance. “We’ve seen nothing like the kind of property bubble that has grown up in the US and UK, so there is good reason to think that Asian growth will hold up pretty well,” he adds.

The big question seems to be whether the US and European economies will slow down enough to affect Asian exports, but Williams believes that both India and China are well protected in the fact that much of the demand is generated by domestic consumers. “But some of the smaller economies like Singapore, Malaysia and Taiwan are very reliant on exports to the US and Europe”.

Another gauge of how healthy emerging markets are is the premium that has to be paid by borrowers. This has been steadily increasing in recent months, making loans much more expensive and initiating questions about whether borrowers will actually be able to pay off their loans when due dates fall.

Refinancing Loans

Dutch bank ING has calculated that $111 billion worth of emerging market bonds will have to be refinanced in the next year. With credit tight, there is doubt as to whether corporate borrowers will be able to refinance their loans.

Das doesn’t believe that we will see a sovereign debt default problem, where countries are unable to pay back their loans. Instead, the focus will be on banks and companies “that have been major issuers into the credit bubble”.

He goes on to say that, “Russia, Kazakhstan and Ukraine had a number of banks issuing debt. They haven’t all lost access [to credit], but if even Gazprom is having to pay higher [interest rate] spreads [on loans], you can be sure that the weaker names will continue to have a much harder time getting bond deals done”.

The information in this article is courtesy of Mark Rice-Oxley (“Emerging Markets Hit Hard by Wall Street Crisis”, The Christian Science Monitor, 24 September 2008).

Buy property in South Africa.