Emerging markets have lost momentum throughout the past year, as investors adjust to the changing macroeconomic climate. According to news outlets (MarketWatch, Bloomberg, LibertyStreet) global risk aversion is to blame. Though emerging economies are still poised for more GDP growth than their developed counterparts in 2014 – 2.2% versus 4.9% – they aren’t expected to increase that growth rate by much in ’15 and beyond.
Growth prospects that are relatively weak in comparison to previous estimates (though still strong in comparison to other economies) is one reason why investors are pulling out of emerging market economies, as evidenced by capital outflows in those markets (IMF). Another is the outlook for developed economies, particularly the United States, which looks much better than it did a year ago. Now that investors expect the U.S. economy to recover and interest rates move away from the zero lower bound, they expect new financial opportunities to emerge in developed economies as well. Now that investors think they’ll be able to make a decent return in an advanced economy, there’s less of an incentive to take on the risk associated with emerging markets. There is evidence of this if you look at capital outflows immediately following Ben Bernanke’s speech in May 2013; it seems that the cautiously positive economic outlook Bernanke conveyed in his speech led to a sell off in emerging markets that has continued for the past year. Some economists have justified this phenomenon using the VIX as an indicator of risk aversion
Capital outflows put emerging market economies in a tight credit position, constraining their growth potential. Previously they had enjoyed abundant credit because investors in advanced economies had to go abroad for financial returns. Furthermore, it has been shown that Quantitative Easing and related policies in the U.S. put downward pressure on interest rates in emerging markets, facilitating even easier borrowing. This shouldn’t come as a surprise since financial markets are becoming increasingly integrated, but it could pose some problems by limiting the effectiveness of domestic monetary policy (full discussion on if/how us policy affects global market here). Integrated financial markets are generally a good thing, though , and the fragmentation that currently plagues most of Europe is a pertinent example of that.
I’m going to write a follow-up on QE and the role of expectations in the next week or so (after I finish reading the IMFs global economic outlook), and hopefully delve deeper into the current situation in emerging market economies.