Shedding light on emerging risks

EMERGING market investors have faced testing times this year. Russia’s rouble crisis is just the latest shock. But deeper challenges loom.

A currency exchange sign in a Moscow window this week. Given a tumble in oil prices and the ruble’s value, Russia faces a tough 2015.

EMERGING market investors have faced testing times this year. Bonds, currencies and stocks have been volatile. Russia’s rouble crisis is just the latest shock. But deeper challenges loom.

First, growth isn’t what it used to be: between 2005 and 2009, emerging-market growth outstripped that in the developed world by 5.5 percentage points on average, according to International Monetary Fund data. Over the next five years, that gap is forecast to be just 2.8 points.

True, expected emerging-market growth of 5 per cent next year is still healthy, compared with 2.3 per cent for advanced economies. But the slower pace will still have implications for those countries that have failed to recognise shifting growth patterns and adjust their economic models accordingly.

Second, monetary policy in the developed world is shifting. The US Federal Reserve, while remaining “patient” on raising rates, is on the road to tightening. The European Central Bank and Bank of Japan are heading in the other direction. But the vast ­majority of emerging-market ­liabilities are denominated in ­dollars, UBS points out: US interest rates will have a bigger effect than those in Europe or Japan.

Third, the fallout from the plunge in oil and commodity prices will continue to reverberate, with Brent crude down more than 40 per cent this year. Not only will it divide countries into winners and losers — broadly, commodity consumers versus producers — it may also change capital flows. Data on this is hard to come by. But to the extent that flows of petrodollars from oil exporters have found their way into emerging stock and bond markets, there could be less support in 2015.

Fourth, some high-profile ­defaults may test sentiment. Ukraine’s bond debt may yet be restructured, and Venezuela looks headed for trouble. That should only be a minor headwind, however. The problems facing these countries aren’t new, and defaults shouldn’t be a surprise.

More troublesome problems may lurk in the corporate debt market, particularly in Russia if sanctions continue to cut companies off from international capital markets. Corporate debt has been one of the big growth areas for emerging markets as ­investors have hunted for yield.

Russia looks almost certain to face a tough 2015; political risk in Brazil and Turkey could also cause concerns. But if emerging markets sell off as a whole, investors should be looking for opportunities. Countries such as India and Mexico that are reforming their economies may get caught in the downdraft of volatility, ­although would offer a chance to add exposure.

That reflects the fact that “emerging markets” is increasingly an inadequate label for a diverse set of economies. They are vulnerable to some common factors, as the market appears to treat them as homogeneous. But with each year, smart investors will be rewarded for treating them more as individual nations than as an asset class.

The Wall Street Journal