The current circumstances of high uncertainty in the political and economic arena do not favour investments in the emerging countries. Investors in general, and particularly those positioned in the emerging markets, are extremely worried about the impact of an interest rate rise in America. Higher rates in America are likely to draw capital away from riskier emerging markets.
That is probably why Latin America, which is viewed as riskier than Asia or Easte
rn Europe, has been more affected than any other emerging region. The volatility data for the different Morningstar emerging markets categories highlights this. The three-year standard deviation is 27% for the average Latin America fund, 24% for Central and Eastern Europe funds and almost 22% for Asia excluding Japan funds.
Since the beginning of the year the MSCI Latin America index has fallen 10.5% while the MSCI Asia index has lost 5.6% and the MSCI Eastern Europe index has gained 3.6% over the same period. Brazil has been the biggest negative contributor to Latin America’s fall as the MSCI Brazil index has dropped 22.1%. The Mexican index on the other hand rose 7.2%.
Country disparity
The disparity between these two Latin American markets is in some way understandable. Mexico is much less preoccupied than Brazil by the predicted American interest rate increase. For Mexico, the North American economic recovery is more important because of the country’s high dependence on exports to its northern neighbour.
In this sense the latest data which showed a higher than expected increase in industrial production – 6.4% in annual terms – is a positive sign for the country even if the Bank of Mexico has recently tightened its monetary policy. The bank had moved to prevent any pickup in inflation, which was 4.2% for the year ending March 2004.
Brazil, in contrast, still needs to borrow a lot of money from abroad to finance its deficits. Brazil’s foreign-borrowing needs for the rest of this year amount to some $40 billion (£23 billion) and around 20% of government debt is linked to the dollar. So the impact of an American interest rate rise as well as a strengthening of the dollar is negative for the country.
There is also a tremendous difference between these two countries on the commodity front. Mexico is one of the most important oil producers in the world. The rise in the crude oil price is consequently benefiting the country. Brazil for its part is one of the countries that has most benefited from the Chinese growth as China is one of its most important commercial partners. Therefore, Brazil is tremendously exposed to the risk of a cooling off of the Asian giant’s economy.
Debt markets affected
The fear of an interest rate rise in America has also affected the emerging bond markets. The JPM EMBI+ index, a benchmark for emerging market bonds, has declined more than 8%, as measured in dollars, over the month ending May 13th. It is down 7% from the beginning of the year. Much more dramatic has been the decline for the Brazilian bond market with the JPM EMBI+ Brazil Composite index losing close to 14% from December 31st 2003.
But despite these huge declines many analysts argue that the situation is quite different from the 1998 Russian debt crisis or the 1994 Mexican Tequila crisis. No important emerging country is going through any major fundamental difficulties, they say. They also insist that in 1994 most of the emerging market countries had fixed exchange rates and current account deficits whereas today the countries generally have current account surpluses and floating exchange rates. They view this fall as a normal price correction as emerging market bonds have received massive investment inflows in the past months which have made them a little expensive.
