Recent volatility in the major financial markets has had ripple effects on the emerging economies especially the fragile five – Turkey, India, Brazil, South Africa, and Indonesia.
The emerging markets are currently facing 4 major concerns:
1. The Chinese economy’s growth rates are slowing – China is a very important trading partner for many emerging markets.
2. There is the prospect of monetary tightening in the US which could increase interest rates. This then leaves investors a dilemma. Do they continue to invest in emerging markets with volatile growth prospects or take the now safer option by investing in U.S. Treasury bills which are perceived to have no default risk.
3. All these economies have significant current a/c deficits which means that they rely on overseas funding to pay for domestic consumption and investment.
4. Politically they are unstable which makes the implementation of reforms near impossible.
It is important to remember that before the tapering of QE purchases liquidity in developed countries has gravitated towards higher returns in emerging markets and the carry trade. Since the start of the tapering process the volume of money into emerging markets has fallen which means that they will have to tighten up their own budget policies or reduce investment and domestic consumption.
Turkey – political problems – current account deficit – exchange rate depreciation.
Argentina – political problems – high Inflation – exchange rate depreciation (Peso has fallen 14% since 22nd January).
India – very high inflation = higher interest rates = reduced domestic consumption
Brazil – similar to India – very high inflation = higher interest rates = reduced domestic consumption
Indonesia – current account deficit – slow growth – budget problems with US tapering.