Emerging markets; turning a corner
Emerging markets have been attracting healthy investment flows into their stock and bond markets for much of this year and now data compiled by consultancy CrossBorder Capital shows the sector may be on the cusp of decisively turning the corner.
CrossBorder and its managing director Michael Howell say their Global Liquidity Index (GLI) — a measure of money flows through world markets — showed the sharpest improvement in almost three years in June across emerging markets. That was down to substantially looser policy by central banks in India, China and others that Howell says has moved these economies “into a rebound phase”.
This is important because the GLI, which has been around since the 1980s, has been a fairly accurate leading indicator, leading asset prices by 6-9 months and future economic activity by 12-15 months, Howell says:
Weak liquidity has been the key reason why EM shares have underperformed for so long. More liquidity may now allow EM markets to catch up.
The picture isn’t perfect. CrossBorder’s Global Liquidity index measures currently at 47.8, where a number above 50 denotes expansion. But the number in emerging markets was a still-low 24.1 last month, though it was 20.4 in May and is up 8 points this year.
Also, emerging central banks rather than private sector companies are behind the uptick in liquidity in most markets. More than half of them are now running loose liquidity policies while three-quarters have been easing over the past six months, Howell says. So private sector cash flow generation is not great.
There are some bright patches, however. CrossBorder measures Indian liquidity conditions at 60.5 (China was at 48), a rise of 20 points this year and partly a consequence of buoyant capital inflows. The central bank’s dollar purchases have expanded money supply while foreigners’ bond buying has fuelled a steady decline in borrowing costs (10-year yields have fallen 100 bps since February peaks).
The ability to monetise inflows - to buy hard currency that releases local currency into the market and eases liquidity – via dollar-buying interventions is crucial, Howell says. He divides emerging markets into three groups:
First are those such as India which have strong inflows and have been monetising them. Then you have the middle group of most emerging markets such as Turkey where reserves are stable and the central bank can take the risk of easing policy. The last group is where reserves were falling and policy actually has to tighten to keep the currency stable.
Check out our piece here to see how reserve accumulation in emerging markets is shaping up.