Woes and Opportunities in the Emerging Markets

kuala-lumpur-170985By Stephanie Tsui

The emerging markets have experienced the fastest capital outflow in nearly two years, with US$ 2.5bn being withdrawn from emerging-market bond funds last week, and a total of US$ 38bn billion being pulled from emerging-market equities funds so far this year, according to Barclays and Bank of America Merrill Lynch. The MSCI Emerging Market index has fallen more than 20% from this year’s high in April to hit a near four-year low.

The Commodity-driven EMs are facing increasing pressure, as oil prices hit a six-and-a-half-year low and a broader index of 22 commodities compiled by Bloomberg was at its lowest level since 1999; China, the largest trade partner of most of the emerging economies, saw dwindled demand as its PMI dropped to a 77-month low. In addition, the surprise devaluation of the RMB has sent shock waves through the currency market, possibly pushing its trade partners to depreciate their currencies one after another to regain competitiveness.

Market observers noted that the outflows have been triggered by concerns around the expected Fed rate hike, slowing global growth and weakening currencies. Fears have been raised that a rising dollar would accelerate capital outflows from emerging economies and lead to further weakening commodity prices, while dollar-denominated debt would become a bigger burden for most cash-strapped governments and companies.

Due to the increased deficits and accelerated capital outflows, currencies in these countries have fallen hard in the past year. Mexico’s peso, Brazil’s real, Indonesia’s rupiah have plunged 23%, 36% and 12.5% respectively against US dollar in the past year. Russia’s ruble is now at its lowest level in six months; South Africa’s rand plummeted to an all-time low of beyond 14 to the dollar on Monday, and the Indian rupee hit its lowest level since September 2013 on Monday.

In the first quarter of this year, foreign-exchange reserves in emerging markets have dropped US$ 227bn or 3%, the biggest percentage loss for a quarter in six years, according to the International Monetary Fund, as most countries have used their Foreign reserves in an effort to prop up their weakening currencies, in addition to the huge capital outflows.

“In general, we believe that EMs are in an economic malaise driven by a myriad of issues which may require a multi-year healing process,” said Schroder in a research report.

Nevertheless, some other experts still believe there are investment opportunities, as the emerging markets are quite divided. In fact, some markets with solid fundamentals have become attractive for investors after the recent correction.

Russ Koesterich, Global Chief Investment Strategist of Blackrock, noted on his blog that emerging economies with characteristics of current account surpluses, ample foreign exchange reserves, or commodity importers are better positioned than others to withstand capital withdrawal from financial investments.

He recommended Malaysia, as it “amassed a current account surplus and significant foreign exchange reserves thanks to export-driven economic growth, whose current account-to-GDP and foreign exchange-to-GDP measures have consistently beaten an average of 21 large emerging market economies on a quarterly basis.”

In addition, he preferred countries with greater willingness to consider and implement market reforms.”Korea and Taiwan, along with countries like Mexico, are also levered to US growth and are likely to enjoy a bounce if the US economy accelerates in the back half of the year.” Koesterich said. BM