By Martin Hunchinson, Investing Daily
Developing economies are suffering their biggest capital outflows since the Financial Meltdown, according to the Economist. In some cases, that’s deserved – Brazil and Russia are badly run, while Ghana got over-excited by its new oil wealth and started spending too much. Now it’s running a huge balance of payments deficit.
But for most emerging markets, especially those with solid balance of payments positions, the outflow will be a short-term problem for one very good reason: their policies are better than those of the rich world in many cases.
It’s not the first time since 2008 that emerging markets have had a liquidity squeeze. The “taper tantrum” of mid-2013 was especially hard on them. In general you’d expect this. Emerging markets have less solid credit positions than most developed markets, since they mostly need outside capital to assist their development. So when credit tightens, emerging markets get hit first and hardest.
That’s why, of all statistics, balance of payments is most important in assessing emerging markets’ health. If a country is sucking in capital and running a big balance of payments deficit, then it will fall into a credit crunch. Conversely, countries that can grow their economies while keeping a positive balance of payments are in no danger from a credit crunch, and should continue prospering.
So in Africa, Nigeria and Zambia have balance-of-payments surpluses and are in less danger than Ghana and Kenya, which have large deficits. Similarly, in East Asia advanced economies (Taiwan, South Korea and Singapore), and many emerging economies (Philippines, Malaysia) run balance of payments surpluses, and so are solidly protected from a credit crunch.
The other key to the current emerging markets credit crunch is that it is the result of an extreme monetary policy followed mostly by rich countries. We have now had U.S. and British interest rates at zero for nearly seven years, Japanese interest rates at zero for 17 years, and even Eurozone interest rates at 0.5% or below for two years.
That’s not true in emerging markets. In most you will find the central bank policy rate only around the rate of inflation, rather than several points below it as in rich countries.
We used to think, following Milton Friedman, that ultra-loose monetary policy would set off surging inflation. That no longer seems likely – or if it is still going to happen, the time lags involved are stupendous. However, interest rates below the inflation rate set off a surge in misguided investment, producing office buildings, oil projects and tech startups that will fail in the next downturn, dragging the economy with them.
That suggests that the risks involved in investing in rich country stocks are currently pretty high. However since most emerging markets haven’t made the same monetary policy mistake as rich countries, then most of them don’t have this overhang of dodgy investment waiting to crash down.
In the final analysis, if you avoid the countries with bubbles and big balance of payments deficits, and the countries like Russia that are simply kleptocracies, emerging markets may offer more safety for your money right now than Western countries.
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