Emerging markets: turbulence ahead

Headwinds are gathering strength as the MSCI emerging markets index takes a dive.

The MSCI Emerging Markets index has slid sharply from early May's six-month high and a lasting rebound looks unlikely. Headwinds are gathering strength: the US economy is gaining momentum and a rise in US interest rates, the first in ten years, is consequently expected in the autumn. A higher yield in the world's biggest economy tends to lower demand for risky assets, and so implies that money is likely to leave emerging-market stocks and bonds.

Capital outflows are always difficult for countries with big current-account deficits, which need foreign cash to cover their shortfall with the rest of the world. Moreover, as world debt markets are priced off US ones, higher US yields may mean tighter monetary policy in emerging markets as well.

To make matters worse, many countries have piled on debt in recent years. Their total borrowings have hit 175% of GDP, an increase of 30% since 2009. Around $2trn of that is borrowings in US dollars, propelling the total to $4.5trn. High foreign currency borrowings add to risks, since they become more expensive to repay

as the US dollar rises against emerging-market currencies. Many emerging economies put off structural reforms during "the years of easy growth from cheap money and commodity earnings", says the FT. They are now bracing themselves for the worst turbulence since 2013. The worrying thing is corporate debt, says Paul McNamara of GAM. "There's been a tidal wave of issuance and... investors have rushed in without necessarily knowing about the idiosyncrasies of the market."

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