The riskiest emerging markets for investors

Investors have started to turn their backs on risky assets, exposing these emerging markets to higher interest rates.

Last May, emerging markets "went into freefall" when the US central bank hinted that it would taper (gradually reduce) its money-printing programme, says Chris Wright on Forbes.com. The prospect of higher interest rates in the US prompted investors to turn their backs on traditionally risky assets.

Once tapering was finally announced late last year, emerging markets took it in their stride. But this smooth start hardly rules out "a disorderly adjustment scenario" akin to, or worse than, last May's turmoil, says the World Bank.

If there is such a panic, the amount of money flowing into developing countries could drop by as much as 80% for several months, the World Bank estimates. So which countries would be most vulnerable to a "sudden stop" like this?

Clearly, it's the ones that depend the most on foreign capital in the first place the ones with big current-account deficits.

Countries with current-account deficits spend more on imports than they raise from exports. This gap has to be financed by borrowing money from the rest of the world. The bigger the shortfall, the more foreign capital the economy needs.

When global monetary policy is loose, financing is cheap. But when rates rise it becomes more expensive. If a deficit is very large, countries will have to pay ever-higher interest rates to fill it, "making the problem worse, in something of a vicious spiral", says Schroders.

One of the main ways a dearth of foreign capital hits growth is through local firms being starved of credit. Raising local interest rates to tempt foreign money back just makes things worse.

Another key factor is the proportion of a country's foreign debt that is short term (the more short term, the more vulnerable the nation), and the size of its foreign-currency reserves (which can potentially offset the withdrawal of foreign money).

By looking at how well these reserves cover the gross external financing requirement (GEFR the current-account deficit plus all external liabilities due in the next 12 months), Schroders has uncovered the most vulnerable nations.

Turkey looks most exposed. Its reserves cover just under one year of its GEFR. Chile, Indonesia, India, South Africa, Hungary and Brazil can cover one to two years. At the other end of the scale are South Korea, Taiwan and the Philippines whose exports should also benefit from the global recovery.

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