If you’re having flashbacks of Elton John singing “Candle in the Wind” or Leo helping Kate fly, don’t be alarmed. It’s not actually 1997. It sure does feel like it though. Concern over China’s
inevitable potential crash and Fed tapering have sent emerging markets spinning. In response, Turkey (+5.5%), South Africa (+0.5%) and India (+0.25%) have each raised its key rate to support the lira, rand and rupee, respectively. The streets of Bangkok, Kiev and Buenos Aires don’t look terribly inviting either, while other countries are also on watch as investors have pulled $12bn out of emerging markets year-to-date.
The current situation isn’t rocket science. Since 2011, near-zero interest rates and QE created an environment in which easy flowing money went looking for higher returns than what the developed world had to offer. With US bond yields rising (albeit slowly), there is less of a “search for yield” in emerging markets and money is flowing back out. With demand in the US, EU, Japan and China still weak, many emerging market nations are having difficultly supporting the balance of trade through exports. Without capital inflows to compensate, these countries are seeing their currencies come under pressure (amongst other reasons).
In addition to its indispensable fast food analysis, our old friends at The Economist also created a fairly useful tool called the Capital Freeze Index (see above). This index ranks the country’s most exposed to a freeze in capital inflows based on four key considerations: 1) the current account balance; 2) levels of short-term external debt and external debt payments relative to government reserves; 3) credit growth; and 4) financial openness.
Spoiler Alert! Turkey sits on top of the index. Thailand,
Indonesia, Malaysia and the Philippines have learnt from the ’97 crisis by building up greater foreign reserves and having more flexible currencies. These countries are far from out of the woods, though. While the Capital Freeze Index is a few months old now, it still seems instructive and may be something to keep an eye on, especially if you hear Celine Dion creeping in the background.