Emerging-Market Sell-Off Intensifying

Investor's Business Daily

India's rupee suffered its worst one-day loss in nearly two decades Wednesday, with emerging markets continuing to struggle as Federal Reserve taper fears and Syria concerns exacerbate underlying economic problems.

India's currency fell as much as 3.7% vs. the dollar to a new low. The rupee rebounded somewhat after the Reserve Bank of India said it would sell dollars directly to state oil companies. Spiking prices of oil — one of India's biggest imports — exacerbate its and many other developing nations' issues over rapidly rising inflation and shrinking profit margins.

Rupee Rupture

The rupee has collapsed 24% against the dollar this year — the most in Asia — amid a litany of economic woes. GDP growth has halved in the past year, while the government has pursued market reforms half-heartedly.

The rupee's crash amplifies foreign investors' stock losses. The MSCI India Index has fallen 8.5% in 2013 in local currency, but 24% in dollars.

Emerging market stocks have underperformed developed mar kets for more than two years. They've failed to regain their 2007 high, unlike U.S. stocks, despite superior economic growth .

Trade deficits in recent years have ballooned in India, Indonesia, Brazil, Turkey and South Africa. Imports jumped on domestic demand while exports to ailing Europe shrank.

"The drag from their current accounts is dragging down their own growth, and as their growth weakens the capital that's needed to fund that current account deficit is flowing out," said Srinivas Thiruvadanthai, research director at the Jerome Levy Forecasting Center in Mt. Kisco, N.Y.

The Fed has injected trillions of dollars into the U.S. economy over the past five years, but much of that flowed into emerging markets. Now, with the central bank poised to slow its bond buying and Treasury yields rising, the capital has been rushing out. The hot-money exodus lays bare structural problems, such as poor infrastructure, rife corruption and layers of red tape.

Central banks have hiked interest rates to try to prop up their currencies, but that curbs borrowing, further deteriorating growth prospects. All the while, banks reduced lending to emerging-market borrowers to scale back risks in the wake of the financial crisis.

Busy September Seen

Investors should brace for more volatility next month amid a flood of potentially market-moving events, including Germany's election and the Fed meeting, said Anton Bayer, CEO of Up Capital Management in Sacramento, Calif., with $160 million in assets under management.

"Compound that with political upheaval, and investors may unwind their riskiest investments," Bayer said.

Bayer dumped his emerging markets holdings in December 2010, seeing U.S. import and export growth peak. He also expected that the safe-haven dollar would rally as global economic growth slowed, thereby "limiting the value of emerging market commodities and their ability to export.

Emerging markets are adjusting as key drivers of a 15-year bull run — low rates and heavy Chinese commodity demand — wither, Bank of America Merrill Lynch economists say.

"The outperformance of emerging markets over the past decade, kick-started by the 9/11 terrorist attacks and subsequent peak in the U.S. dollar and China's entry into the WTO (World Trade Organization), is now reversing," they wrote in a "Global Investing Strategy" report released Aug. 21. "And with current-account deficits (rising) again across emerging markets, the asset class once again looks vulnerable to a China or bond-market-driven crisis.

Interest rates, rising around the world, would have to fall for emerging markets to regain their bull run, the report added.

Indonesia's stock market, as tracked by the iShares MSCI Indonesia (EIDO), crashed hardest among emerging market ETFs this month. The ETF has plunged 24.4% to its lowest in 2-1/2 years. Indonesia's GDP grew less than 6% in Q2, the slowest since 2010.

The central bank lifted its policy rate 50 basis points to 6.5% in July and has taken other actions to try to control rising inflation, support the weakening rupiah and stabilize the financial system.

But its current account deficit widened to 4.4% of GDP in Q2 as foreign demand for commodities fell, especially from top trading partners China and India.

"As commodities (particularly raw ones) account for around 60% of the country's total exports, Indonesia feels the impact of the weak international market," R.M.A. van der Schaar, an analyst at Indonesia-Investments.com, wrote Tuesday. "In the 2000s, Indonesia felt the advantages during the commodities boom. Now, however, it is feeling the negative impact.

IShares MSCI Philippines Index ETF (EPHE), one of last year's top-performers, has fallen 18.3% in August to an 11-month low. WisdomTree India Earnings ETF (EPI) dropped 14.7%, returning to its May 2009 price.

Vanguard FTSE Emerging Markets ETF (VWO), the largest developing markets ETF with $49 billion in assets, fell 4.8% . It's on the cusp of falling back into a bear market, as defined by a 20% correction from a 52-week peak.

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