Emerging equity markets in crisis, little relief in sight: IIF

Tokyo

EMERGING equity and currency markets are in crisis, and bond markets in emerging economies appear poised for a fall, the Institute of International Finance (IIF) warned in a report on Friday.

In a highly bearish assessment of prospects, it suggested that emerging equity markets in general could be headed for a long-term downturn. The IIF added that while mature equity markets have fallen less dramatically in the recent China-led rout, their volatility has spiked worryingly upward, especially in the US.

The Washington-based IIF, which speaks for some of the world's leading banks and other financial institutions, had warned several weeks ago that emerging markets appeared headed for a perfect storm; its latest report confirms that this storm has now broken.

Emerging-market equities in general have crashed by 40 per cent since their most recent peak in April, the report noted. The declines far exceed those in mature markets over the period.

"Seven years after the Great Financial Crisis, the world's equity markets have experienced another bout of sharp sell-offs, accompanied by a spike in volatility," the report said.

"While prices have fallen across the board, the decline in equity and currency values across a range of emerging markets has reached crisis proportions."

The selloff in emerging market equities and currencies reflects the economic slowdown during the transition from the old commodity- and export-driven growth model to one that is more balanced and sustainable, it added.

"Until that transition is complete - and different emerging market countries will progress at different speeds - emerging market financial assets are likely to remain under pressure."

The IIF suggested that even if the US Federal Reserves were to postpone raising interest rates beyond September - an eventuality which market participants increasingly seem to expect - it would provide only short-term relief.

Emerging equity markets have been on a decline since 2011, when the super-cycle in commodities turned into a down phase, it said.

"If experience is any guide, such downturn phases of a commodity super could last 15 to 25 years," it said.

The second leg of the deceleration of emerging-market growth occurred when world trade, which used to grow twice a fast as global gross domestic product, slowed markedly, and then has now gone into modest decline.

World trade growth has been closely correlated with economic growth and corporate earnings in emerging markets, so the recent slowdown does not augur well for these markets.

Meanwhile, signals from the US Fed suggesting that it is ready to begin raising policy interest rates has sparked net outflows of around US$300 million from many emerging markets over the past year, said the IIF, which monitors such flows.

"The scale of these outflows (has been) similar to that last seen during the 2008 global financial crisis," the report noted, adding that the intense market pressure has driven a a sharp decline in emerging market currencies.

"On top of everything else, most emerging market countries have also had to deal with downward pressure on long-term potential growth, driven by slowing productivity and labour-force growth."

Chinese equity market gyrations have been the chief catalyst behind the emerging-markets slump, the IIF said.

"The key to stabilising this negative interaction between Chinese and (other) emerging-market growth prospects will be whether China can implement measures to support growth while not detracting too much from economic reform and rebalancing."

The IIF suggested that although emerging-market corporate bonds have been "relatively resilient" during the equity market slump, they could be "the next shoe to drop".

Weaker economic growth in emerging markets, allied with sharp declines in equity values, has increased the probability of default among many corporate borrowers, the report said. It added that many of these corporates have incurred "very high levels of debt".

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