Why outflows are threatening emerging markets

Why outflows are threatening emerging markets (Part 1 of 6)

Why emerging market outflows are hurting local equity markets

Emerging markets outflows

Outflows from emerging markets have caused local equity markets to fall sharply in recent weeks. This series explores why that happened, who the key players are, which countries are most vulnerable, and where this situation may head.

Emerging Markets vs US 2013-09-13Enlarge Graph

How did this mess start?

Cheap money! During the aftermath of the last financial crisis, the historical low rates in the United States as well as Europe provided investors with abundant cash at very cheap rates. Plus, since the performance of developed markets equities weren’t satisfying investors, investors went hunting for higher-yield opportunities in emerging markets.

For almost four years, emerging markets benefited from level inflows that bolstered the foreign direct investment into the countries. As a result, currencies strengthened, consumer demand expanded, and markets rallied.

Where did it go wrong?

As the emerging economies prospered, wage inflation started to settle in, slowly starting to squeeze margins. Initially, it didn’t matter, since growth was keeping up with inflation, but with the Fed’s talks of shutting off the cheap money valve, foreign investors started to repatriate their cash. There were two key triggers that started the outflows.

  • The first was that China (FXI) scared the world by posting slower growth at the same time that its government decided to take no action.
  • The second was that the end of quantitative easing meant the dollar would strengthen—at the expense of local emerging market currencies.

The following two articles explore each of these triggers in more detail.

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