Emerging markets have always posed extreme risk due to external factors of volatile nature such as instability in terms of politics, rising trade deficit and not to mention, monetary risks. While it is almost certain that the chances for loss are on the higher end, it is also true that an investor would seek to invest in the Emerging Market(EM) to experience volatile, but high returns.Since March2018, the Emerging Markets have been facing turmoil. The instability in Turkey certainly did not help the situation. The fall of the Turkish lira which then caused spillover effects on the Euro market as well, had its result in net capital outflows from emerging markets and caused a further fall for EM. This can be evident in the fact that Spanish banks give loans to countries like Indonesia, and Turkey,making this Spill-over effect or the domino effect inevitable.
Turkey did seem to have a whole series of problems in the previous month with the falling lira, sanctions in place by the United States of America, and the retirement of their Deputy Governor of the Central Bank. But finally, they came through with a much-needed interest rate hike earlier this month by the Central Bank of Turkey. This did strengthen the lira, marginally so, to the U.S Dollar but set a record new high level for inflation in the country. At the moment, the Central Bank seems to bepulling out every trick up their sleeves in order to maintain price stability in Turkey. But the large current account and the need for a stronger fiscal policy is the need of the hour.
Apart from this, the Argentinian Peso is not doing very well in the market either, with almost 40% fall in the peso when compared to the US Dollar in this year alone, hinting trouble for Argentina. Their economy seems not to have its public expenditure cuts in relation with the spiralling inflation, leaving the people, prices and most importantly the peso far worse off than before.At this point, one needs to focus their attention on the real issue here- The United States of America. The USD seems to be strengthening at a better pace and along with that, the Fed interest rate hike in the country seems to only make it better for them, but problematic for EM. Investors would start to see the USD and the US market as far more stable alternative to invest in, not to mention making it more expensive for emerging markets, also leading to major capital outflows from their markets.
The problem doesn’t end there. With the whole trade war looming between China and the US, it is creating an aura of uncertainty and panic. The surrounding EM countries who have benefitted from the Chinese Economy all these years will be facing issues from the repercussions of this trade war, which is more of a war of egos between the head of states of the two countries who gamble with goods worth billions from both these countries, while EM faces the brunt as they rely heavily on exports to fuel their growth. But on the flip side, there are contradicting views which talk about how this trade war between China and the USA could call for better long-term policy level changes which would benefit long-run investments by investors as the fund operates under a horizon that would last decades, essentially looking past the noise in the short-term.
But this proposition seems highly unlikely, simply because EM countries will not make such drastic policy level changes for the long-run without it ever having any effect on the short-run. The problems which will accrue to the EM countries, especially those in the Asia region is a particularly worrisome situation due to the deep-rooted connection between each of the markets. Also, it is impossible to have international policy level changes for these EM markets as they seem to rely on goods which are either agricultural or manufacturing in nature. This type of goods will always be volatile in the international markets, not only due to the nature of the commodity but also due to volatility in the international price index. These commodities which are produced from EM countries are subjected to decreasing returns, and with the rise of protectionist policies by countries like USA, it will only cause strain for EM. The market that they source their exports to, is closing off its borders. Now, no amount of pre-emptive policies taken up by EM to mitigate their losses will help beyond a point,as international oil prices are also on a rise.
The sanctions against Iran by the USA and the ultimatum given to other countries to cut ties with Iran pose a big challenge. The rise in oil prices, rise in current account deficit of these EM countries, trade wars, rising USD and the rising dollar related debt for EM countries hint at a rather meek future for the market.Earlier this September, we saw that that hike in interest rates do not always work, and to quote Srinivasan Siva Balan- “Rate hikes do not work at all, and especially so if you are late for the party”. This is especially true and clearly points out that there should be some level of realization to solve a fiscal problem with fiscal instruments and not with monetary instruments, and then expect a solution for the problem.
The growing uncertainty in these EM countries is an important point of contention and a fact, which would determine the future of this market as a whole. The trade war is a stagflation shock to the global economy, whose repercussions if materialized, are yet to be discovered. But with respect to EM and its investors, it does seem that the investors are going to be more selective with respect to individual EM country selection for investments in response to specific individual policies enacted in each countryand taking into consideration the inflationary expectations. An important point to be noted is that the US Dollar and the interest rates are on a rise, which can only mean one thing for investors- regardless of whether they need to ride out the wave of short-term volatility and eventually reach EM stability with increasing returns, or complete fall in the EM market for a longer duration of time, the fact remains that long-term investments is the key to the EM puzzle, although issue of valuations is still a big mystery.
Picture Credits : msci.com