Where to hide in an emerging market rout

December 30, 2014

By Andy Mukherjee

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Emerging markets follow the biblical rule of seven lean years followed by seven rich ones, according to Harvard University economist Jeffrey Frankel. Every fifteen years, a crisis erupts.

By that measure, a rout is almost due. Developing economies have seen six years of brisk credit growth, fuelled by cheap global money. Private and public debt has ballooned. Since the end of 2007, the surge has been 90 percent of GDP in China, 30 percent in Brazil, and 40 percent in the Czech Republic.

These types of excesses typically stop abruptly. Seven years of frenzied petrodollar recycling in Latin America ended with a debt debacle in 1982. A seven-year boom preceded the 1997 Asian crisis. The trigger for the next rout could be an uncontrolled rise in U.S. bond yields, leading to an exodus of capital from developing nations.

Where can investors hide if emerging markets get into trouble? There are three possible sanctuaries. In Eastern Europe, growth has plunged in sanctions-hit Russia, and slowed in Poland. But Hungary under Prime Minister Viktor Orban is growing faster than before the 2008 crisis, and the forint has regained some of its lost competitiveness. Hungary’s trade is in surplus, and its credit overhang is unwinding.

In Latin America, slowing Chinese demand is ending a decade-long boom in commodity exports. Trade deficits are widening in Peru; surpluses are dwindling in Brazil and Chile. GDP growth has stalled in Venezuela and Argentina. Mexico, led by President Enrique Peña Nieto, stands out. Its trade is balanced, growth is reasonably strong, and credit expansion is muted.

In Asia, the country that comes closest to a sanctuary is the Philippines. Growth is rapid, and government finances are in much better shape than before. In a 2015 beauty pageant, the Philippines might lose out to some larger economies which could reap a reform-led bounty. Still, India and Indonesia are risky bets, while South Korea is flirting with deflation.

Since the brief selloff of mid-2013, many emerging markets have sacrificed domestic demand to reduce their reliance on hot money. For them, the lean years may have begun without a meltdown. Even then, few developing nations appear ready for long-term U.S. bond yields of, say, 4 percent. If the skies darken, Hungary, Mexico and the Philippines are the most attractive shelters.

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