Abheek Barua: Emerging market anathema

The tension in Ukraine and other nations, and the murky picture in China, is fuelling the disenchantment

There are many dimensions to the lingering crisis in Ukraine but from an investment flows or financial markets perspective, it is yet another confirmation of the fact that the emerging world is a risky place to be invested in (this is not to deny the fact that the developed markets will feel the pinch of the sanctions in Russia but in terms of fund flows the emerging markets or EMs are likely to take the bigger hit). This comes at a time when sentiment towards EMs is already pretty negative and the Crimean fracas could just add to the bulk of "sell" calls on EM assets.

Ukraine, incidentally, is not the only EM where there is political conflict - tensions in Venezuela, Nigeria, Thailand and Turkey are certainly not abating. As Maarten Jan Bakkum, the EM strategist for ING investments, points out in his latest report (Emerging Market Equities Monthly - ING Investment Management, March 2014), the economic data flow does not help the EM case either. Macroeconomic imbalances in a range of countries from Brazil to Indonesia are deteriorating. All this is happening at a time when the growth engines in these economies have slowed considerably. In short, it's not a pretty picture.

To top it all, China's economic landscape looks murkier than ever. This is important since China is considered a bellwether for emerging markets as a whole, not just for Asian markets but given its growing economic ties with the rest of the emerging world, for other markets as well. China's exports collapsed in February after a period of relatively comfortable exports and a spike in January. While it is somewhat risky to read too much into just one data release, the export numbers gave rise to two sets of concerns. First, eroding competitiveness might mean that China could be losing market share in developed markets. The fact that the central bank, People's Bank of China, had to increase the yuan's trading band by a percentage point and push the currency to the lower end of the band (depreciate) seems to indicate that there is indeed a problem with exports. The second concern relates to whether some of the healthier export figures earlier reflected real trade or merely an accounting trick of over-invoicing exports to get capital back into China. This could become a more generalised problem regarding the credibility of China's data.

Mercifully, the bulk of analysts believe that China will not "hard land" and both the government and the central bank would step in to spur growth. There is some evidence of this already - credit disbursal (that is directed by the central bank to a considerable degree) picked up in January and the bank pumped in liquidity in February to cool down overheated money markets. I would not rule out the possibility of some fiscal pump-priming as well. The problem this time around (China's policy hotshots have, in the past, never batted an eyelid when it came to providing "stimulus") is that it might go against China's new policy of fiscal rectitude and transition to a more transparent and disciplined monetary policy.

The disenchantment with EMs also comes at a time when the US Fed is steadily winding down its monetary stimulus quantitative easing (QE) programme. While a steady taper is anticipated and "priced in" by the market, it is important to read the fine print. In its monetary policy statement released on March 19, (in which it reduced the QE amount by another $10 billion), the Fed somewhat predictably assured the markets that it would keep the policy rate for a "considerable period" well after QE is wound up. Chairman Janet Yellen dampened spirits by pointing out that "considerable period" actually meant a period of just six months after the end of QE. The implication is that the Fed could consider a rate increase early and not wait for the third quarter as the financial markets had factored in. The new set of forecasts released by the Fed pegs the policy rate at one per cent instead of the 0.75 per cent indicated earlier. All this could mean that the Fed is getting convinced that simply turning off the liquidity tap might not be enough in an environment of rising growth but some change in the cost of liquidity is also warranted to ward off the evils of a hyper-expansionary monetary policy.

Tailpiece: I am alarmed by the recent forecasts by some heavyweight banks that the rupee might reverse course and go back to levels of 47. This would effectively mean massive bubbles in other markets, stocks and bonds that could compromise financial stability. It would also leave the rupee significantly overvalued yet again and breed the risk of yet another episode of depreciation, when the markets do a reality check and realise that a current account deficit coupled with an overvalued exchange rate spell disaster. I have a niggling suspicion that the rupee is unlikely to appreciate beyond the high fifties, both because the euphoria of a stable government will play off against the effects of a tighter US monetary policy and also because the Reserve Bank of India will buy dollars to replenish its war chest of reserves.

The writer is with HDFC Bank.
These views are personal