Emerging markets: what’s up? This is one of those days when everyone seems focused on emerging markets. Partly this is because of lack of news flow.
Here’s my take on what’s going on:
1. the fundamentals for emerging markets have been deteriorating for a while, but money flows have been supporting them;
2. growth since 2009 has been helped largely by those money flows, powered by stimulus programs in the U.S. and China, and even some of the emerging market countries themselves;
3. as easy money has begun to dry up, foreign investment has been coming out of these countries;
4. emerging economies are now facing several problems: stimulus—both domestic and foreign—is expiring, low commodity prices are likely to remain low absent more stimulus from China, and higher bond yields making it harder to borrow money;
5. now that the “tide has gone out,” there is a focus on what has been lacking in the emerging market countries: debt restructuring and (with the exception of China) infrastructure investment.
Take China, for example. Credit has surged, so there are parts of the economy that are very over-leveraged. There is not enough cash flow to service all the debt. China has a choice: a) a debt restructuring, or b) more stimulus. At the moment, more stimulus does not appear imminent. It would be beneficial to pursue a debt restructuring, but near term it means more pain. Significantly more pain.
And that’s the problem facing all these countries (including the U.S.): no country has proved capable of enduring the pain necessary for debt restructuring.
India is the canary in the coal mine, not China. If you want a sign of how serious this is getting, look at what is happening in India, where the rupee is hitting new lows against the dollar. Many are taking rupees and exchanging them for dollars and other currencies.
Now there is talk that there may be capital controls instituted–limits on the amount of money that can be taken in or out of the country, or–just as bad–limits on the convertibility of the rupee into other currencies.
Indian officials have denied they need to do that, but even the rumor of it is bad news. It would send a very bad signal to the markets: that they have lost control of their currency. That would exacerbate the problem, as people would likely find ways around it. The black market would flourish.
In July the Indian government instituted restrictions on gold imports that temporarily halted gold imports, causing massive confusion. Imagine what would happen with currency restrictions?