Markets: Is the Asian miracle over?

The past four years saw $3.9 trillion of funds flow into emerging markets. In the blink of an eye, $12 billion dollars of debt and equity holdings have been repatriated from India alone since May 22.

The exodus has hit local debt, with foreign holdings at the lowest in 19 months to $28.7 billion.

This could mark the end of Asia being the golden child of global growth.

Withdrawals were sparked by concerns the Federal Reserve will pare back the current monetary stimulus. Equity markets globally have begun to price this in and the implications for emerging markets are starting to heat up.

The past four years have seen emerging markets thrive on renewed capital inflows, which led to a credit boom that must end eventually. As a result they have imported more than they export, leading to current account deficits that are set to become problematic.

Without sustainable growth systems in place, emerging markets are especially vulnerable to dramatic changes of in and outflows to their economies. The consequences range from sharp devaluations in local currency to crippling domestic inflation.

The impact of the thought that the Federal Reserve will peel back the existing quantitative easing program has reduced demand for assets in emerging markets. As a result, we are now seeing a global shift of the allocation of funds. Those funds that once flooded emerging economies are now racing back to the perceived safety of developed markets.

Emerging market investors enjoyed asset prices bolstered by the cheap global funds, made available by quantitative easing. Perhaps they thought emerging markets were less risky than they actually are.

India’s equity market is leading the way down, with its benchmark index the CNX 500 recording a 13.1 per cent fall since 22 May. China’s Hang Seng and Brazil’s Ibovespa Index are down 10 and 10.5 per cent respectively.  In comparison, the ASX 200 is only down 1.7 per cent and the US-based S&P 500 is flat.

In conjunction with sliding asset prices, both India and Brazil are facing weakening currencies. The rupee has lost over 12 per cent and the Brazilian real 14.7 per cent against the US dollar since 22 May. India’s currency is now trading at its lowest level ever against the US dollar.

To stem the depreciation of their currency, the Reserve Bank of India has increased interest rates and mopped up liquidity from the banking system. On the surface this measure will provide some immediate support for the currency, but the consequence is crimping already meek domestic growth.

We will begin to see the aftermath of currency depreciation as domestic inflation becomes uncontrollable, crippling the economy and further crushing domestic equity valuations.

Valuations across emerging markets are only back to long term averages. The shift we are seeing out of India and similar markets is encouraged by other markets, such as Europe offering better value at present. This is just the beginning for emerging markets.