Past few months have proved to be quite ugly for emerging
markets investments. While these markets in general had a
lackluster performance earlier this year, investor sentiment
deteriorated rapidly after the Federal Reserve hinted at scaling
back its asset purchases. Stock markets in these countries
suffered steep declines and currencies rout further added to the
Emerging economies had been dealing with the problem of excessive
capital flows until just a few months back. Ultra-low interest
rates in most developed economies sent trillions of dollars to
emerging countries in search of higher yields and growth
opportunities. The reversal began with the 'taper' talk even
though actual tapering is yet to start. (Read:
3 Cyclical ETFs for an Improving Economy
While the markets seem to have stabilized as of now, the problem
remains unresolved and we will most likely see another round of
panic when the Fed actually starts reducing the asset purchases.
At the same time, many analysts believe that the sell-off has
been overdone and some of these markets offer excellent long-term
investment opportunities at current valuations.
Remember that these countries are still growing at much higher
rates than the developed world. Per IMF's World Economic Outlook
(updated in April 2013), developing economies are expected to see
growth rates of 5.0% and 5.4% respectively in 2013 and 2014,
compared with 1.2% and 2.1% for advanced economies.
However, growth rates for emerging economies will most likely be
revised down slightly at the time of their next update in October
and the rates for the developed economies may go up thanks to
better than expected recovery in Europe and Japan.
With rapidly changing emerging markets investment landscape, it
is time to delve deeper into country fundamentals before deciding
where to invest. (Read:
European ETFs-A Surge in Popularity
Hot Money Flows Reversals-Which Countries are most
Countries that are dependent on 'hot money' to finance their
external deficits are the most vulnerable to rising interest
rates in the US. These countries largely depended on cheap
foreign capital to finance their capital account deficits. Other
key factors to consider are ratio of short-term external
debt to foreign exchange reserves and the ratio of volatile
capital flows to total flows.
Countries have a large oil import bill, like India, Turkey and
Indonesia and Thailand remain vulnerable to any spike in oil
prices if tensions in the Middle East escalate again.
Current A/c Balance (% of GDP)
Stock Market Performance (YTD)
Currency Decline Against USD (YTD)
Did Policy Actions Succeed in Halting the Slide?
ISHARS-MS INDON (EIDO): ETF Research Reports
WISDMTR-IN EARN (EPI): ETF Research Reports
ISHARS-MS POLND (EPOL): ETF Research Reports
ISHARS-MEXICO (EWW): ETF Research Reports
ISHARS-S KOREA (EWY): ETF Research Reports
ISHARS-BRAZIL (EWZ): ETF Research Reports
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Sudden flight of capital has left many central banks struggling
to come up with appropriate policy responses. Brazil's central
bank announced a $60 billion intervention program to halt the
currency slide and has raised the rates for the fourth time since
While several earlier measures announced by the Indian central
bank to slow the outflows had backfired as market participants
feared that country may be moving towards stricter capital
account controls, some later market friendly proposals made by
the new central bank governor raised some hopes about the
India ETFs Rebound on Central Bank Steps
By some estimates Indonesia and Turkey spent between 15% and 25%
of their foreign exchange reserves in trying to protect their
currency. Indonesia and Turkey also raised their rates to try to
attract the capital back to the country. Howver these
currencies are still down in double digits against the the US
Countries like South Africa which do not have enough reserves and
further do not have much flexibility to raise rates in view of
alarmingly high employment rate, are at highest risk. No wonder
the currency has lost about 18% against the US dollar.
Is a Repeat of 1997 Possible?
Many emerging countries have accumulated large holdings of
foreign exchange reserves, as they tried to halt the appreciation
of their currencies in the face of strong capital inflows duing
the past few years.
Reserves give them some flexibility to prevent or at least
decelerate the slide in their currencies when hot money suddenly
flows out. Further, most of them have flexible exchange rates
unlike in 1997 when countries with fixed exchange rate regimes
were forced to devalue their currencies.
In fact, they are more likely to allow the currencies to decline
moderately as weaker currencies will make exports more
attractive. At the same time, they are prepared to
intervene in times of excessive volatility.
Strong Leadership and Structural Reforms Necessary for
For long-term success, macroeconomic platforms in these countries
have to be supported by structural reforms. Countries that have
failed to institute market friendly measures are likely to be
punished by foreign investors in coming years. Mexico which has
been a frontrunner among the emerging markets in the area of
structural reforms, managed to largely avoid the meltdown.
Rampant corruption and brazen populist policies being adopted by
the ruling parties have only added to the woes in countries like
India and Indonesia. (See:
Russia ETFs-Immune to Emerging Markets
Current political leaders in Mexico and Philippines have also
demonstrated strong resolve to tackle corruption and in fact they
have been very effective in bringing down corruption and tax
The Bottom Line
While the imminent end of the era of cheap money is one side of
the story; at the same time, not all emerging markets are the
same. Current crisis has just brought to the fore the structural
problems that were already existing in some of these countries.
Countries like India, Indonesia, Brazil, Turkey and South Africa
are most likely to continue to suffer in the coming years.
On the other hand, countries that have instituted structural
reforms at making their markets open and competitive in the long
term will emerge as long-term winners.
Mexico, South Korea and Poland have largely avoided the melt down
due to their lower dependence on hot money and sound
macroeconomic fundamentals. As growth in China picks up,
Philippines and Malaysia could also benefit.
Mexican currency displayed remarkable resilience when other
emerging markets currencies suffered steep declines. The outlook
for the ETF tracking the country--
iShares MSCI Mexico Capped Investable Market Index Fund (
-has also improved as US economy picks up momentum as about 80%
of Mexico's exports go to the US.
South Korea has greatly reduced its dependence on external
capital after the 2008 crisis and with excellent institutional
framework and open market policies, the country could be poised
to deliver excellent returns over long-term. Further as global
economy continues to slowly recover,
iShares South Korea ETF (
should benefit from its focus on export sector.
With its sound economic fundamentals and strong policy
frameworks, Poland looks like a winner among the emerging Europe
ishares Poland ETF (
could be an interesting investment pick now with easing of the
headwinds from the rest of Europe.
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