1. EM: Who is vulnerable?
Markus Jäger, Deutsche Bank
The EM economies most hit by the current spike in global risk aversion are those that attracted the largest inflows of ‘fickle’ capital in recent years. In response to financial market volatility, most EM policymakers have opted to let their currencies depreciate rather than tap foreign reserves.
Poland and Turkey have low foreign reserve levels relative to other EMs as seen in the Deutsche Bank chart, but Jäger believes they are still sufficient to avert a crisis. In particular, he points to Poland’s flexible credit line with the IMF, which reduces the economy’s vulnerability to a drying-up of capital inflows.
EM Muser: I looked at this issue in a post back in October: Which Emerging Markets Appear Vulnerable? A Look at Early Warning Indicators. Turkey, and to a lesser extent Poland, also stood out as vulnerable based on my analysis. In addition to low levels of foreign reserves, both are running current account deficits. Turkey’s is particularly large and is estimated to reach a very high 10% of GDP for 2011.
I agree with Jäger that the flexible credit line will help insulate Poland from crisis. However, I think Turkey looks quite vulnerable, at least in the near-term. Its high external financing needs leave it very exposed to a sudden stop in capital inflows. Right now it’s largely a confidence game.
2. Indonesia: Land Bill to Help Infrastructure and Enhance ‘Structural Goldilocks’
Deyi Tan and Seen Meng Chew, Morgan Stanley
Indonesia’s parliament passed a long-awaited bill that will move forward much needed infrastructure projects on December 14, according to Reuters. Prior to its passage, analysts at Morgan Stanley detailed why this would be a positive step forward. They believe the increase in infrastructure spending will help raise Indonesia’s potential growth to around 7.0-7.5% by 2015.
EM Muser: As I argued in a post last month, Indonesia is a relative bright spot in today’s global economy. (See: Indonesia: Ugly Duckling No More.) The country boasts a large domestic market, a growing population, low debt levels, relative political stability and smart policy making.
The passage of this land bill represents another reason to be bullish on Indonesia especially since analysts viewed weak infrastructure as one of the major structural constraints on growth. The bill is also likely to prompt sovereign ratings upgrades. (December 15 Update: Fitch raised Indonesia’s credit rating to investment grade following the bill’s passage. Moody’s and S&P continue to rate Indonesia below investment grade.)
Following December 4 parliamentary elections, roughly 50,000 people took to the streets in the biggest protests in over a decade. The ruling United Russia party narrowly won with 47% of the vote amid widespread fraud allegations. The boiling over of dissatisfaction with the government surprised analysts and overshadowed news of the expected approval of Russia’s WTO entry later this month.
Despite the outpouring of anger, Danske does not expect widespread protests in Russia like those seen in the Middle East and North Africa earlier this year. Moreover, Danske still expects Vladimir Putin to emerge victorious in the March presidential election as “he is the only viable option.”
EM Muser: The protests spurred Russian billionaire Mikhail Prokhorov to announce himself as a challenger to Putin in the coming presidential race. Skeptics believe Prokhorov’s candidacy is government-sanctioned in an effort to defuse growing tensions. In any case, the March presidential race just got more exciting and political uncertainty in Russia will remain elevated.
4. How the role of equities may shrink
McKinsey Global Institute
A new McKinsey report points to the transformation of emerging-market households into a powerful new investor class. Their share of global financial wealth is expected to rise from 21% to as much as 36% of global financial wealth by the end of 2020.
EM investors behave differently than those in mature economies and are less likely to invest in equities, according to McKinsey. “This shift is being exacerbated by aging and other trends in the developed world that are dampening investor appetite for equities. As a result, equities could decline from 28% of global financial assets in 2010 to 22% in 2020.”
EM Muser: If McKinsey is right, then demand for equities in EM markets will not keep up with supply. This, in turn, will raise companies’ cost of equity. While this is bad news for growing companies in these markets, it could result in higher returns for EM equity investors. (Unfortunately, I was only able to access the summary. If anyone is able to send me the full report, I’d greatly appreciate it.)