The past few months have proved to be quite ugly for emerging
markets investments. While in general, these markets had a
lackluster performance earlier this year, investor sentiment
deteriorated rapidly after the Federal Reserve hinted at scaling
back its asset purchases.
India and Indonesia have been two worst sufferers of the reversal
of investor sentiment. Popular ETFs tracking these markets like
India Earnings Fund (
) and MSCI Indonesia ETF (
) are down more than 20% year-to-date. In contrast, the broader
iShares MSCI Emerging Markets ETF (
) is down only about 7%. (Read:
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Both these countries are dependent on foreign capital to fund
their current account deficits, which will become difficult when
the era of cheap money ends. Their dependence on foreign capital
led to mass exodus of spooked foreign investors, leaving stock
markets weak and currencies battered. At the same time, the
crisis brought the macroeconomic fundamentals back in focus.
Macroeconomic Fundamentals Worsening
Indian economy recorded ~8% average growth rate during 2006-11
and Indonesia grew at an annual rate exceeding 5% in seven of the
past eight years, mainly due to increasing consumption by their
rising middle class. (See:
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Both economies are now slowing down; Indian economy grew at just
4.4% in the last quarter, its slowest rate in a
decade while consumer price inflation in the country
is close to 10% now.
Indonesia's central bank revised the expected growth rate down to
a range of 5.5 to 5.9% recently, as the country has been hit by
slackening demand and weak prices for its commodity exports.
Inflation continues to creep up in the Southeast Asian nation.
In the past couple of years both these economies benefited from
their domestic focus; with consumption accounting for more than
two-thirds of GDP, they were largely insulated from the global
economic headwinds. Now as the recovery gains momentum in the
developed world, emerging countries that are more geared to
developed market growth are likely to perform better.
Deficits and Debt
While current account deficit has been a perpetual problem for
India, Indonesia recorded a current account deficit in 2012 after
14 years of surplus.(Read:
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India's current account deficit which had grown to about 7% at
the end of 2012 has moderated slightly this year; it was 4.9% of
GDP during the first quarter of the current fiscal year. But,
India's short term debt has been growing.
With foreign exchange reserves at around $270 billion, India has
a reserve coverage ratio (short term debt and current account
defcit as a % of foreign exchange reserves) of about 1.1 times;
slightly better than that for Indonesia.
Recent Measures Taken
The sudden flight of capital has left these central banks
struggling to come up with appropriate policy responses to
curtail the outflows and halt the currency slide. (Read:
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Indian central bank has taken a number of steps since the crisis
started including a recent repo rate rise. Some of the market
reforms proposals made by the new central bank governor raised
hopes about the economy and the Rupee has recovered significantly
Indonesia has raised its benchmark interest rate by 150 basis
points since June. The central bank also intervened in the
foreign exchange markets several times to halt the currency
Indonesia's trade account recoded a small surplus in August after
a massive $2.3 billion deficit in July. Further inflation
also eased to 8.4% for September from 8.8% in August. These
improvements suggest that the measures taken by the government to
slow down the economy are finally working.
Both countries suffer from structural problems like crumbling
infrastructure, rampant corruption, and lack of political resolve
to implement market reforms or curb populist subsidies. Further,
economic nationalism has been on the rise in Indonesia. With
elections due in both countries next year, any significant push
to reforms or to curb populist measures like ballooning subsidies
should not be expected anytime soon.
Is the Worst Over?
Both these countries have stabilized and worst may be over for
now but they are definitely not out of the woods. There may be
another round of panic for these markets when the taper talk
returns. Even after the recent recovery, Indian Rupee is down
about 12%, whereas Indonesian Rupiah is down almost 16% year to
Several steps taken by India to curb gold imports---which account
for a large part for the trade deficit, may help the current
account going forward. Further a cheaper Rupee works well for
exporters in India, specially IT exports. On the other hand,
Indonesia's exports are largely dollar denominated and thus do
not benefit from a cheaper Rupiah.
Raghuram Rajan, the new governor of the Reserve Bank of India
aptly cautioned "let us remember that postponement of tapering is
only that - a postponement…..we must use this time to create a
bulletproof national balance sheet and growth agenda that creates
confidence in investors…".
So unless these countries take solid measures to contain their
deficits and spur growth as well as introduce substantial
structural reforms, their markets will remain vulnerable to
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