Tuesday, June 25, 2013

QE reversal: how bad is it for emerging markets?

Quantitative easing, which sent money flooding into emerging markets, is due to be reversed. It will be a slow reversal, nevertheless, the trend is clear enough. How badly will it hit emerging markets. FT lists a number of positives in emerging market economies in today's environment compared to, say, the 1980s or 1990s:

In many respects, the developing world is also strong enough to deal with any fallout from a change in the US monetary regime. During previous crises, many countries had pegged exchange rates, low reserves, rigid economies and big US dollar-denominated debt burdens. These vulnerabilities have mostly been addressed.
The latter factor – what economists call the “original sin” of emerging markets – has in the past proved particularly toxic. Historically a strengthening US dollar has spelt trouble for emerging markets due to currency pegs and foreign liabilities. But classic original sin has now been much reduced.

.....Emerging markets are also far less indebted than developed countries. The overall credit-to-gross domestic product ratio is about 70 per cent against the 145 per cent average for advanced economies, according to the International Monetary Fund.
And although economic growth has disappointed recently, the IMF still estimates that output in developing countries will expand an average of 6 per cent annually between 2013 and 2018. Ample foreign currency reserves will act as insulation against any market chills.

Even if money is less freely available, the distribution of it between developed and emerging markets could change, given better growth prospects for the latter. Leading funds could increase their allocations for emerging markets:
Norways's $700 bn sovereign wealth fundlast year changed its bond index to give emerging markets a bigger weighting. Other big SWFs have followed suit. But many investors have been slower. US pension funds and insurers have an average of 4 per cent of assets allocated to emerging markets but many aim to double that over time. Each additional percentage point increase in portfolio exposure would funnel $485bn into emerging market bonds alone, according to estimates by BlackRock.
What does this bode for India? Our problem is not the wide current account deficit alone; it is faltering growth, given that private investment has dried up. Unless public investment can take its place, growth prospects will not improve and foreigners' willingness to finance our deficit will be not be strong. That said, our strong point is the long-term allure of the Indian market. FII flows will be hesitant but FDI flows should continue- note that the average FDI flows into India post the financial crisis has been higher than in the boom period before the crisis.

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