How will Latin America be affected by the emerging markets crisis?
It’s been a nervous start to the year for Latin American central bankers and finance ministers. US monetary tightening and falling commodity prices have combined to create a perfect storm of investor panic in emerging markets. By Valentines Day investors had pulled more than $29billion from emerging markets bond and equity funds in 2014, more than the total for all of 2013. As a result Latin American markets have been sent tumbling.
The causes of the crisis are nothing new but investors can be an irrational bunch at times and this year they hit the panic button. One reason for the extreme reaction is a sense of déjà vu. The recent panic gives investors with long memories a flashback to the Asian crisis of 1997, when cracks appeared in the region’s fast-growing, supposedly ‘tiger’, Asian economies. The first pressure point was Thailand, where a shock currency devaluation triggered a wave of defaults and recessions across the emerging markets. So when the Argentine peso fell 15% in one day in January many investors feared that we were due a repeat.
’97 all over again?
The four most dangerous words in investing are “this time it’s different”. Repeatedly markets teach the same lessons to investors who really should have known better. But, loathe though I am to utter those dangerous words, there are some clear differences this time around.
One is macroeconomic fundamentals. If we take Argentina and Venezuela out of the mix most of the Latin American economies are in much better shape than they were before. As Neil Shearing points out in a recent Capital Economics research note, many LatAm countries have used the commodity boom to build up healthy foreign reserves – this means that the region’s central bankers now have considerable firepower to protect their economies. Another advantage is that much of the capital flowing to their economies now comes from foreign direct investment (FDI), in long-term projects, such as infrastructure or commodity extraction. Unlike the so-called ‘hot money’ invested in bonds or shares, these project-related investment flows are harder to turn around and subsequently less affected by short-term market panic.
But that’s not to say that Latin America is bullet proof. Unlike a few years ago, when many ran surpluses, now all of the region’s economies are running current account deficits. “People say that current accounts deficits of 4% are manageable”, says Jorge Unda, chief investment officer at BBVA Mexico, in a recent interview with LatAm INVESTOR. “That’s true but you also have to ask yourself how you will correct the deficit if the main sources of growth [such as commodity exports] aren’t there.” Another problem is fiscal weakness, says Unda. “You have low interest rates in general in emerging markets, while many have embarked on quite expansionary fiscal policies.” Nevertheless Unda is optimistic, noting that unlike in 97, there is a clear remedy for the affected countries. “The solution is to either let the currency depreciate – so stop the ranges and the central bank intervention and just let it go. Or embark on dramatic fiscal tightening. Of course neither one of those is likely to prove politically popular.”
So far various Latin American finance ministers have been trying to assuage international investor’s fears, ‘explaining’ why their particular country won’t be affected. And with emerging market investments picking up in recent weeks, it would seem that the first stage of the crisis has abated. Yet if history is anything to go by, the panic will come back. When it does, we’ll find out which of the ministers was telling the truth.