How dependent on that money are emerging economies? The amount of emerging-market bonds and equities that foreigners have accumulated is impressive (see chart 2). But the income and wealth of the emerging economies have also grown over that period. The 30 most prominent such economies account for almost 40 percent of global GDP, notes the Institute for International Finance, which represents global banks. Yet their weight in benchmark portfolios of global stocks is only about 13 percent.
As a group, the emerging economies are actually net exporters of capital to the rest of the world. Even as they have attracted large private capital inflows, their central banks have engineered an even greater capital outflow by accumulating big foreign-exchange reserves. They smoked foreign capital but they did not inhale, as Martin Wolf of the Financial Times once put it.
That is true of the group as a whole. But it is not the case for every member, some of whom breathed deep. Turkey, South Africa, India, Brazil and, latterly, Indonesia have all run troublesome current-account deficits, which have left them vulnerable to capital outflows. Moreover, the current-account is “only the bit of the balance of payments that you can see above the surface,” notes Kit Juckes of Société Générale. Countries can experience large and potentially destabilizing capital flows in both directions, even as their current account remains roughly in balance, if inflows differ greatly from outflows in their liquidity, maturity or currency.
India and Indonesia have tried to limit their exposure. India has narrowed its current-account deficit dramatically, helped by a ban on gold imports. Indonesia cut fuel subsidies in June and taxed luxuries that are largely imported. And both countries let their currencies fall — a symptom of overstretch that (by encouraging exports and deterring imports) is also a partial remedy.
Having endured big falls since May, the currencies of both India and Indonesia have stood up well to the recent turmoil. The currencies of South Africa and Turkey have not. Their rate hikes this week will help to restore the higher real yields their assets must pay to attract foreign investors.
But according to Mr. Juckes, this absolute yield differential is not all that matters. Once rich-country pension funds are earning more than a derisory amount on staid investments at home, they will be far more reluctant to venture into anything “exciting” abroad, even if the spread between domestic and foreign rates remains the same in absolute terms. “Part of me wants to look at interest-rate ratios not interest-rate differentials,” he says. In other words, if American 10-year yields go up from 2 percent to 3 percent, it is not enough for emerging-market yields to go up by one percentage point. They have to go up by half.
As real long-term interest rates rise above zero in America, global investment managers are going through an enormous “one-off adjustment,” Mr Juckes reckons. They are anticipating a “more normal world,” in which pension funds can meet their obligations by holding safe but rewarding assets in countries they know well. It was a world America began to leave behind in late 2007, when the crisis broke and the dramatic rate cuts started. At that time, curiously enough, the central bank of Turkey’s “Locus of Extremity” was on loan to America’s Federal Reserve.
© The Economist Newspaper Limited, London (February 1, 2014)