By Ian Fraser
Emerging market economies are even more exposed to the vagaries of global financial markets than at the time of the Asian crisis of 1997, according to new research from the International Monetary Fund (IMF) which, in its usual slightly hectoring tone, is also recommending steps they can take to protect themselves from at least some of the fallout.
The IMF said that, even after two decades of investing in emerging markets, international investors are no less prone to manias and panics than they were 15 years ago and that there is little sign of them taking a more mature approach. The IMF said that investors' tendency to mimic each other's choices - so-called "herding" behavior - has not declined either.
The changing profile of those who invest in the stocks and bonds of emerging markets, and the vehicles through which they invest, has played a part in exacerbating the swings. In the 1990s, investment in emerging market economies was restricted to narrowly-focused (and often geographically specific) equity funds. However, in its latest Global Financial Stability Report, published in full on 9 April, the IMF said that savers in developed economies are increasingly channeling their money through global mutual funds, which invest both in advanced and emerging market economies. Sovereign wealth funds and central banks are also stepping up their investment in emerging market economies.
Retail funds are more likely to behave like proverbial "headless chickens" than institutional funds, with many dumping holdings of emerging market equities and bonds at the first sign of trouble. The IMF said:
"Many of the small investors putting money into mutual funds are less informed savers who may panic-sell at signs of volatility. Mutual funds also invest in stocks and bonds that performed well in the short run, while selling those that did badly - a strategy called momentum trading. This may contribute to induce boom-bust cycles in asset prices."
However, the Fund said that during the sell-off of emerging market stocks and bonds in 2013 and early 2014:
"institutional investors such as pension funds and insurance companies with long-term strategies broadly maintained their emerging market investments."
Gaston Gelos, who heads up the global stability analysis at the IMF, said:
"Knowing who the investors are is critical for understanding the evolving stability of capital flows into emerging markets, especially when the uncertainty over advanced economies' monetary policy remains high."
The initial sell-offs of emerging market assets in May/June 2013 were triggered by remarks from the then chairman of the Federal Reserve, Ben Bernanke, who warned of an unwinding - or "tapering" - of the US central bank's quantitative easing (QE) program. Emerging markets have also been hit by a number of distinctive problems including those that have afflicted Argentina, Syria, Ukraine, Turkey and Russia. At that time, global investors started treating emerging economies with better fundamentals differently from those with weaker ones.
The IMF suggests that the best way for emerging market economies to insulate themselves from investors' erratic behavior is to further strengthen and deepen their own financial systems. It said economies with more developed services sectors and more liquid financial markets are better placed to cope with international investors' mood swings. The report concluded:
"Therefore, policies to promote a more developed financial system will better equip emerging markets to reap the benefits of financial globalization, while reducing its potential costs."
Slim Feriani, chief investment officer of London-based fund managers Advance Emerging Capital, sees the current slump in emerging market equities as a buying opportunity. He said:
"The discount in emerging markets valuations relative to developed markets is back to levels last seen in 2004 and, historically, this has represented an exceptional entry point for patient, long-term, contrarian investors."
Mark Mobius, emerging markets guru at Franklin Templeton Investments, is banking on opportunities for services companies in emerging markets, especially in China, Nigeria and Indonesia. Mobius also recently upped the exposure of the $12bn Templeton Asian Growth Fund to Thailand.
Former trader and author Satyajit Das takes a different view. He is highly critical of the West, accusing it of effectively sabotaging many emerging market economies through self-centered policies including currency devaluation and QE. The effect has been to destabilize emerging market countries by diminishing the value of their holdings of developed world sovereign debt and driving excessive amounts of capital to their doors.
Writing in the Independent, Das said that emerging markets have been saddled with losses in order to "preserve the unsustainable monetary and regulatory arrangements of developed nations." He also said many in emerging countries resent the fact the bailout conditions imposed by the IMF on eurozone countries like Greece, Ireland and Portugal were much less onerous than those imposed on Asian countries in 1997-98. Das predicted that when the US Federal Reserve finally ends QE and raises American interest rates, the "fragile five" - Brazil, Indonesia, India, Thailand and South Africa - will bear the brunt. Das added:
"They say that truth is the first casualty of war. International trust may be an early casualty of a global economic crisis."
The IMF will publish the Global Financial Stability Report on 9 April 2014.