The emerging market swoon of 2013: Fed-inspired or just investors dog-tired?
It has been another bumpy ride in most emerging markets this year. Currencies and bourses from Sao Paolo to Mumbai and Budapest to Johannesburg have been beaten down, rebounded, and then were beaten down again. Volatility reigns supreme once again.
None of this is a surprise, of course. Emerging markets are almost hard-wired to be vulnerable to dramatic inflows and outflows of money that induce the kind of dislocation in market valuations we have seen this year. This summer, Ben Bernanke and the U.S. Federal Reserve have been the special object of scorn for emergingmarket central bankers, market regulators, and fiscal policy authors for having inspired the painful capital flow withdrawals they have endured. In June, Mr. Bernanke and his Federal Open Market Committee colleagues laid out a responsible timetable with conditions for the withdrawal of monetary stimulus — the so-called “tapering” exercise. He cautioned that the scale-back in the Fed’s $85 billion per month bond-buying program would only happen if economic data were better and added that interest-rate hikes were still far into the future.
What was the reward for his effort at greater Fed guidance? In the Group of 20 communiqué in September, a number of political leaders expressed grave concerns about what they saw as the turmoil unleashed by the prospect of the U.S. slowing the flood of dollars into the world economy. The leaders of Brazil, China, Russia, India, and South Africa specifically commanded “an eventual normalization of monetary policies to be effectively and carefully calibrated and clearly communicated.” These very countries announced they would commit $100 billion to a currency reserve pool that could help them jointly defend against balance of payment crises. Read: insurance against further Fed policy shocks.
Lots of research has shown that global risks, like unexpected shifts in monetary policy in the developed world, are important factors driving waves of capital flows in emerging markets. As global risks increase, investors either stop investing abroad and retrench to their home-country markets, or they leave their home-country markets and flee to markets with more stable financial systems. One cannot help but wonder, however, if the Fed’s prospect for tapering as a driver of the current swoon, while influential, may be overstated. A more fruitful perspective would be to turn one’s gaze inward rather than wave one’s fist outward. Perhaps emerging market leaders need to focus less on trying to manage external influences beyond their control and refocus their energies in favor of resourcing the kinds of institutions that make it more attractive for global investors as a long-term play. After all, it is these very investors that help these countries solve the undercapitalization problems that impede their long-term growth potential.
What are these institutions that can alleviate global investors’ concerns and thus dampen down excessive capital flow volatility? Research shows that responsible long-term-oriented investors care deeply about market transparency and sound corporate governance standards. They want to reduce arbitrarily tough restrictions on market access for foreign interests and especially the uncertainty about how these restrictions apply and are enforced. Deeper capital markets and more operational systems for the trading of securities are critical toward heightening investor confidence. Global investors care about strong legal protections for minority investors in public corporations in the event of a dispute resolution with respect to actions (or inactions) of family- or management-led controlling stakeholders. Long-term investors also care deeply about a stable political environment.
The good news is that there are lots of examples that emerging market regulators and political leaders are making serious investments in improving these institutions. Consider Brazil’s Novo Mercado, a listing segment of the BM&F Bovespa for the trading of shares issued by companies that commit themselves voluntarily to adopt corporate governance practices above and beyond those required by law. Since its founding over 10 years ago, mostly positive outcomes have been seen in terms of value, liquidity, and capitalraising capacity for the firms that have signed contracts to adhere to a set of good corporate governance practices.
Another good investment is in stronger cooperation among regulatory authorities in emerging and developed markets. This year, the U.S. Public Company Accounting Oversight Board (PCAOB) announced that it had entered into a memorandum of understanding on enforcement cooperation with the China Securities Regulatory Commission and China’s Ministry of Finance. The goal of the agreement is to facilitate joint inspections in China of audit firms that are registered with the PCAOB and that audit Chinese companies that trade on U.S. exchanges. It is a solid step toward protecting the interests of global investors who lean on U.S. institutions, like the Securities and Exchange Commission and the PCAOB, to ensure the integrity of financial statement disclosures and to facilitate good governance practices of the many companies from around the world that list and trade on those markets.
Global investors seek predictable and reliable market access in emerging markets. Almost immediately following his late August appointment, Reserve Bank of India’s Governor Raghuram Rajan announced a series of reforms to liberalize the banking sector, to strengthen capital market institutions, and to close some gaps in securities market regulation. It came not a minute too soon, with the rupee’s dramatic decline and an exit of almost $1 billion from equity markets during the preceding month. Specific proposals included the promotion of more small, private banks; disinvestment in small, underperforming state-run banks; the freeing up of branch licensing rules; and generally greater participation of foreign investors in Indian capital markets.
These are very good developments, but the work is not yet done. So much more can be done to secure the confidence of responsible, long-term global investors to emerging market stock, bond, and currency markets. Investors want to see a bigger effort toward increasing operational efficiencies of the trading markets, toward limiting or even eliminating arbitrary restrictions on foreign investor access that distort capital flows, toward toughening legal protections for minority investors, and toward blocking potentially predatory government actions that distort well-functioning market mechanisms. Attracting such investors to their shores has to be the best medicine to stabilize underlying flows and to secure financing for the steady long-term growth they so desperately need.