Exams have finally finished and with my last assignment from last semester handed in today it is time to start blogging again. With emerging markets (EMs) dominating headlines recently, I thought it would be fitting to have a discussion regarding their issues.
Having spent a month working at a stockbrokerage in Bangkok I can appreciate the effect the western world has on EMs. Whilst I was working there the main financial data dominating the movement of the SET was the Spanish yield crisis (read about it here). The fortunes of EMs are inexplicably linked to that of the western world, so when the Fed decided to taper at the end of 2013 it was no great surprise that EMs reacted.
When the Fed originally began loosening its monetary policy, such as lowering interest rates and initiating QE, investors started to experience lower returns, as the yield on USA bonds declined. They started to look abroad and as a result EMs saw a significant inflow of dollars as investors, hungry for returns, turned to more riskier assets. As a result their currencies appreciated (supply and demand).
However the Fed is now signalling its desire to reduce its stimulus, by tapering QE, and as a result the funds are flowing back from EMs to the USA. The result of this has been an extremely volatile month, with EMs such as Argentina witnessing a 15% drop in their currency in just one week (source).
Corrupt central banking?
This case is specific to Turkey. Here we define corruption as ‘treating an activity at a lower norm than it is appropriate to’ (Sandel, ‘What Money Can’t Buy’, 2012). In Turkey the central bank is trusted by the public to uphold financial and economic stability, however the Prime Minister Recep Tayyip Erdogan was lobbying, quite successfully, for holding central bank interest rates at their current rates. This could be argued to be a personal gain for Recep Tayyip Erdogan, as he was keeping the economy in an overheated state to provide economic growth and thus (it can be argued) to secure more votes, demonstrating a form of corruption consistent with Sandel’s definition. As a result the independence of the central bank was being questioned and investors began to lose confidence in the Turkish economy. This is a good case study for issues that are rife among transition and EMs, as without confidence in the infrastructure and regulations of a country sensible investors won’t invest.
Nonetheless the Turkish central bank has finally increased interest rates, from 4.5% to 10%, the large jump demonstrating how long the central bank had been delaying the rise. This rise should hopefully bring more inflows into the Turkish economy, helping to shore up their falling currency.
‘Hot flows’ vs Structural reform
Another argument that underpins the weakness of EMs is the idea that they are just attracting short-term deposits and investments (‘hot flows’) rather than long term capital investment. This is a result of EMs not putting in place the structural reforms to provide a long-term investable environment. An example of this could be Burma, where structural reform could include the basic reformation of human rights and the introduction of a democratic, incorrupt government. Without these basic changes companies and investors will not invest in the long-term, due to either moral obligations or just from being risk adverse.
However Shawn Donnan argues against this point, stating that foreign direct investment (FDI) to developing countries is growing and at a much faster rate than developed countries.
Graphs like these help put forward the argument that developing economies are receiving the long-term investment they require (FDI is a longer term investment and can include factories as well as setting up your HQ in the country). However, whilst Donnan puts forward a strong statistical case for long-term investment into EMs, it could just be a result of the current economic crisis, with companies moving from previous hubs (London) to cheaper locations (Hungary, Poland etc). With a recovery on the horizon maybe we’ll see a reverse?
What are your thoughts on this issue? I can’t help but think that countries, such as Brazil and Russia, with their vast populations and resources will surely end up with economies larger than the USA. My personal conclusion would be that structural reforms are vital, as they provide the confidence that investors require to invest in the long term, providing the capital to turn BRICs into developed economies, such as USA, Germany and the UK.