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Emerging markets' turmoil likely to stay contained

Tuesday - 2/4/2014, 4:30am  ET

AP Business Writers

WASHINGTON (AP) -- From Turkey to South Africa to Argentina, emerging markets are being slammed by rising inflation, economic mismanagement and political turmoil.

Overhanging it all is a nerve-jangling unknown: Whether developing countries as a group can withstand the end of the extraordinary easy-money policies that central banks have offered up for five years.

The short answer: A tentative yes.

Many economists say they're optimistic that the troubles in emerging markets won't infect the global economy as a whole. They note that the biggest threats in the developing world are confined to modest-size economies -- South Africa, Turkey, Argentina -- that seem unlikely to do much damage beyond their borders.

For one thing, emerging economies as a group are far healthier than they were the last time they were severely tested -- during the Asian financial crisis of the late 1990s.

Many have built up foreign currency reserves they can use to buy their own currency and prop up its value. When the Asian financial crisis hit in 1997, emerging markets' foreign reserves were equal to 9.9 of their economic output. Many couldn't defend their currencies. By last year, the percentage had risen to nearly 30 percent, according to the Institute of International Finance.

And the world's richest economies -- the United States and Europe -- appear to be strengthening. As they do, they'll be more likely to buy goods from developing countries, thereby cushioning the damage.

"Some emerging markets have been hit particularly hard," economists at BNP Paribas wrote in a report last week. "However, it has only been some, so this is not a widespread emerging-market crisis."

The International Monetary Fund expects the global economy to grow 3.7 percent this year, up from 3 percent in 2013. The IMF forecasts that developing economies as a whole will also grow faster in 2014 -- 5.1 percent, up from 4.7 percent in 2013.

Still, the turmoil in emerging markets this year has shaken global investors. So far this year, Argentina's peso has dropped 19 percent, South Africa's rand 7 percent and Turkey's lira 6 percent. In response, the Argentine, Turkish and South African central banks have raised interest rates to try to curb inflation and support their free-falling currencies. The resulting turbulence has rattled investors in the United States, too: Since peaking Dec. 31, the Dow Jones industrial average has tumbled 7 percent.

On Monday alone, the Dow sank 326 points, or 2.1 percent after a weak report on U.S. manufacturing added to investors' worries about the global economy.

Why have emerging market troubles spooked investors in the United States and Europe? In short, fear of the unknown.

After going to extraordinary lengths to pump money into the financial system after a crisis hit in 2008, the Federal Reserve is scaling back. The Fed's bond buying had pushed long-term U.S. rates down and sent investors into emerging markets in search of higher returns. Now that U.S. rates may be poised to rise, the money is flowing back out, pressuring developing countries' currencies and financial markets.

"Central banks have provided unprecedented liquidity to the markets," says Craig Alexander, chief economist with TD Bank Financial Group in Toronto. "What happens when that liquidity starts to get withdrawn? The actual answer is, we don't know."

Economists have warned that emerging markets must do more to wean themselves from their dependence on easy money -- by improving roads and other infrastructure, reducing dependence on exports, encouraging more domestic spending, reforming their markets and opening up their economies to more foreign competition.

Adding to the tension is trouble in China. The fast-growing Chinese economy is decelerating -- bad news for developing countries such as South Africa and Indonesia that supply Chinese factories with raw materials. On Monday, global markets were shaken by a government manufacturing survey showing that Chinese factory output grew at a slower rate last month compared with December. A Jan. 23 HSBC report showed that Chinese manufacturing actually contracted in January.

Individual emerging market countries are confronting specific problems:


The biggest economy in Africa is beset with troubles. China's slowdown is likely to pinch demand for South African coal and other commodities. Inflation is near a high 6 percent. And investors have been dumping South African assets, causing the currency, the rand, to plummet. In response, the South African central bank last week raised rates for the first time in six years. But that carries a risk: Higher rates could damage a fragile economy, warns Mohammed Nalla, head of strategic research at Nedbank Capital near Johannesburg: "A hike in rates will likely exacerbate the plight of the poor and middle class and accelerate the deterioration in domestic growth," Nalla says. The country is coping with a strike by tens of thousands of platinum miners that threatens political stability.

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