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Emerging market economies have one last chance to shape up
(REUTERS/Ajay Verma) All aboard?
This is it: the end of a remarkable boom in emerging market investing.
In the coming months, economists believe, countries like India and Brazil will need to get their houses in order to survive a dramatic change in the way money has been flowing around the world.
For years, since the financial crisis, emerging markets have found themselves in a rare position: flush with cash from foreign investors and a huge opportunity to make real changes to their economies. So far, few have used it; as that window of opportunity starts to close, this could be their last chance.
Why have things been so good?
Postcrisis easy monetary policies from central banks in the developed world — especially the Federal Reserve's quantitative easing program — have made the developed markets pretty unattractive for investment. That has sent foreign investors overseas in search of higher returns.
Ankur Patel, chief investment officer at R-Squared Macro, a Birmingham, Alabama-based investment firm, says this has been great for emerging markets, but eventually global liquidity will tighten when central banks like the Fed begin to raise rates.
"They have benefitted from it — they've had this big windfall," he said. "But as time gets tough, the question is, will they make the right policy decisions?"
Peter Henry, dean of New York University's Stern School of Business and author of "Turnaround: Third World Lessons for First World Growth," says there is still time for emerging markets to make some changes.
"The best time for structural reform in emerging markets would have been from the outset of the Fed's QE program, before tapering," he said. "The second-best time is today, but next week is better than never."
This wasn't going to last forever
It's not like emerging markets haven't seen this coming. A huge warning sign came in 2013, when the Fed initially announced the end of quantitative easing, resulting in a "Taper Tantrum" in which funds rushed out of the emerging economies and back into US bonds.
(Reuters)
But this year has been particularly good for emerging markets. Not only has the Fed held off on raising rates, but the European Central Bank also started its own bond-buying program. More than two dozen central banks have cut rates, Patel notes, and both the Bank of England and the Bank of New Zealand continue to signal they won't raise rates soon.
Just last week, the Fed released another policy statement, which the market seems to have interpreted as patient. Emerging market stocks have since climbed even higher — all thanks to this global increase in liquidity.
But it's only a temporary breather for these countries.
This time around, when Fed Chair Janet Yellen does begin to raise rates in the US, "the countries that have the most amount of foreign investor exposure will likely get hit the hardest — and they happen to be countries that have large current-account deficits," Patel said.
The Good and the Bad
In 2013, that meant India, Indonesia, Turkey, Brazil, and South Africa. Since then, India and Indonesia have taken real strides to reduce their deficits. (Lower oil prices, especially for India, a net importer, have been a huge boon.)
India's central bank governor, Raghuram Rajan, also had the foresight to start selling rupees in exchange for US dollars and has now built up a solid reserve. But people are beginning to wonder if Prime Minister Modi will follow through on his reform promises — namely banking and financial sector reforms — before global monetary policies begin to shift.
"If your economy is doing well ... your financial markets are doing well, you lose some of that reform momentum — that motivation to actually go ahead with tough reforms," Patel said.
Meanwhile, in Brazil, things have actually gotten worse since the taper tantrum. Inflation is up, the currency, the real, is down, and no one is interested in their commodity exports. Plus, investors are quickly losing all confidence in the political system following the massive Petrobras corruption scandal.
Across the developing world, things need to change, and they need to change soon, experts say.
"It's unfortunate that they've squandered this window of opportunity," Patel said. "They still have some time to make some bigger changes, but the window is closing on them."
And, for Henry, this all has a much wider impact than we might realize:
"The global economy needs emerging markets to stay the course with economic reforms," he said.
Hence the urgency.
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