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America s looming rate rise will expose more frailties in emerging markets
Dec 12th 2015 | SHANGHAI
THE prospect of interest-rate lift-off in America gives investors a reason to
take their money there. So it has been odd to see a procession of
emerging-market officials call on the Fed to get on with it, the sooner the
better. Central bankers from India, Indonesia, Malaysia, Mexico and Peru are
among those who have professed a desire for America s rates to rise.
One explanation is that they are a little like patients waiting to give blood,
tired of the excruciating wait and just hoping to be done with it. Things could
certainly get painful. As it is, capital is already being diverted away from
developing countries and towards America. In 2010-14 non-residents put $22
billion into emerging-market stocks and bonds every month, on average. In
November they moved $3.5 billion out, the fourth month of such outflows in the
past five, according to the Institute of International Finance, a trade
association.
Further outflows in the coming months would put more pressure on the
beleaguered currencies of many emerging markets. Depreciation makes their hefty
external debts even more daunting. Dollar credit to non-banks outside America
reached $9.8 trillion in the middle of this year; a bit more than a third of
that was owed by borrowers in emerging markets, according to the Bank for
International Settlements, a forum for central bankers.
To defend their currencies, central banks can raise interest rates in line with
the Fed. In recent weeks Peru, Chile and Colombia have done just that in
anticipation of lift-off, as have Angola, Ghana, Zambia and others. Higher
domestic interest rates, though, come at a cost, dampening economic activity.
They also make it more expensive for companies to refinance domestically, a
problem since the bulk of their new debt in recent years has been in their
local currencies. Whichever route emerging markets choose to take, in other
words, some pain is inevitable hence the desire to get it over with quickly.
Another explanation for their sang-froid in the face of the Fed is that the
worst might already be behind them. It has been a brutal year for the assets
and currencies of many developing countries. Average real exchange rates for
emerging markets, excluding China, are now as weak as in late 2002, when
investors still had raw memories of the crises of the 1990s.
A decade of furious growth had dimmed those memories, but this year has revived
them. The MSCI index of emerging-market equities has fallen by 15% (see chart),
badly underperforming developed markets and hitting its lowest level since the
height of the financial crisis in 2008.
From this vantage, much of the downside from rising American rates appears to
have been priced in already. Take two of the most battered currencies, the
Malaysian ringgit and the Russian rouble. They are down by some 25% and 50%,
respectively, over the past two years. A steadying of their value would make
nominal corporate earnings in both countries look far healthier in dollar
terms: other things being equal, they would go from double-digit falls to being
flattish. Jonathan Anderson of Emerging Advisors forecasts that the big theme
of 2016 will be a stabilisation trade , as portfolio investors are lured back
to developing countries.
The International Monetary Fund sees a similar trajectory for economies as a
whole. It forecasts that emerging-market growth will average 4.5% next year, up
from 3.9% this year, breaking a streak of five straight years of decelerating
growth. It is not that emerging markets will have suddenly regained their
lustre. Rather, it is that recessions will be less severe, if not over, in
places like Brazil and Russia.
Yet if the best that can be said about emerging markets is that they will
stabilise, this points to a more troubling reason for their relative
indifference: the realisation that the Fed is the least of their problems.
In 2013, investors dumped emerging-market assets when America signalled the
beginning of the end of its programme of quantitative easing. That episode came
to be known as the taper tantrum . This time the gloom that envelops emerging
markets might be more accurately described as a secular sulk .
The fear is that a golden era of growth, fuelled by China s ravenous appetite
for commodities, has come to a close, exposing deep cracks in their economic
foundations. David Lubin of Citigroup, a bank, talks of a broken growth model
. Governments cannot stimulate their economies because their creditors will
not tolerate big deficits. Companies are also unable or unwilling to invest
more because they have built up big debts. Exports are of little help because
many of these economies are now overly reliant on commodities.
The feeble state of manufacturing across emerging markets, with the exception
of parts of Asia, means that many will miss out on the one big upside to
lift-off. The Fed is set to raise rates because of America s relative economic
strength. America, in turn, should provide a boost to countries that make the
things it wants to buy. But emerging markets such as Indonesia and South Africa
that specialise in commodities have not just been hit hardest by China s
slowdown; they are also the least likely to benefit from America s growth. To
them, lift-off will sound like a cruel joke. They will stay pinned to the
ground.