The problem with hot money coming into developing countries is that when the tide reverses, it does so with destructive gusto. Since the financial crisis hit in 2008, first-world central banks have pumped over $12 trillion into the markets, most of which has headed straight for the developing world. Now it is leaving—and no one can quite agree why.
Asian stock markets led the fall on Tuesday with the biggest losses since 2011 in many markets, with Thailand down 5%, the Philippines down 4.6% and Indonesia down 3.5%. Latin America was quick to follow—Brazil fell 3% and both Argentina and Mexico fell 2%.
So what’s going on?
- The immediate trigger was a flurry of poor economic data. The Philippines reported a drop in exports, car sales in India slid again, Mexico’s industrial output dropped and Turkey’s markets and currency were took a beating from anti-government civil unrest.
- Sentiment about developing economies had already been wavering. Russia’s slide towards further authoritarianism and crony capitalism has worried investors, and China’s slowdown looks to be long-term and hard to remedy. Canny fund managers have long been aware that a bubble has been building in many smaller emerging markets, funded by quantitative easing and low interest rates in developed-world economies. Now that the US Federal Reserve chairman Ben Bernanke is beginning to talk about scaling back, investors are jumpy about when and by how much.
- In Japan, the world’s third biggest economy, doubts are growing about the chances that “Abenomics” can rekindle growth in a country that has been stagnant for years. An underwhelming central bank policy meeting revealed nothing new, and Bank of Japan governor Haruhiko Kuroda reiterated on Tuesday that he believed the bank had done enough. Investors appear to disagree.
- The fortunes of the developing world, particularly in Latin America, are tied to commodity prices. As El Salvador’s former finance minister, Manuel Hinds, explains on Quartz, global economic growth is tightly related to commodity prices. But as global construction, industry and manufacturing slows, demand for many commodities has fallen.
- Finally, hot money is jumpy and emerging markets are volatile—the Financial Times describes market rises and falls as a foxtrot (slow, slow, quick quick). The Wall Street Journal says that this is because of “the strong stampede effects of dumb money chasing smart money—these markets tend to be less liquid and relatively small flows can have big effects.”
If emerging market investors are abandoning ship, where is the money going?
- In many cases, back to the US. Bond yields have risen amid speculation that the central bank is about to stop issuing so much debt. This has drawn investors back to safety—US government bonds are considered among the safest in the world—and away from riskier emerging market bonds. Upbeat economic data from the US gives the impression that it is outperforming the rest of the world, particularly a maligned Europe.
- Will the rout last? The first thing to be careful about is avoiding lumping all developing markets as “emerging.” They’re not—China’s sheer size distorts most broad measurements and it operates very differently to South Africa, for example. But most analysts are not optimistic. “This will not be a short-lived sell off,” a senior strategist at Société Générale told the Financial Times. Sergio Trigo Paz, a managing director and emerging markets specialist at BlackRock, told Reuters that “emerging markets are not a safe haven anymore.”