Stock markets in Moscow and copper mines in Chile appear to have little in common. But these are two spots where investors in New York and London have been pumping money borrowed on the cheap to seek out big returns.
Aggressive monetary easing in their home markets helped them to raise cheap funds to pursue such deals. Now, these same investors are scrambling to take their money out, triggering a massive run on emerging markets from Jakarta to Delhi and warnings of a currency crisis.
China itself has become a magnet for substantial foreign capital. It too is not immune to global economic patterns. However, unlike say India, it appears equipped to ride out this storm.
Since 2008 emerging markets including China have sucked in trillions of dollars in capital.
This has been sustained by cheap credit generated in developed nations via “quantitative easing” – printing money to buy assets and inject cheap cash into the economy. The US central bank has been a big contributor to global liquidity. Last September it announced a third round of “QE3”.
What was seen as a short-term program has gone on for almost a year and involves the US central bank buying US$85 billion worth of assets a month. Much of that money has flowed outwards. So when Fed chairman Ben Bernanke in June ventured that the purchases may be “tapered” toward the end of the year, panic set in.
From mid-May to July emerging markets witnessed capital outflows of US$85 billion as investors pulled out money on concerns the tap to cheap credit would be turned off. That has piled pressure on emerging markets that now account for 50% of the world economy.
The prospect of capital flows drying up “has caused increased market volatility, has limited the scope for additional monetary easing, and is putting downward pressure on domestic demand” in these countries, according to a report by BBVA. Investor sentiment has turned negative.
As the biggest emerging market of them all, attention has naturally turned to China.
One of the biggest concerns raised by some economists if major capital flight occurs has been the threat of a new liquidity shortage. A major credit crunch in late June that roiled markets has only heightened these fears. China is not immune to this trend: Net capital outflows were recorded for 2012, bucking a three year trend in 2009-2011; US$17 billion fled in the first half of 2013.
Yuan devaluation could also occur. This would not be good timing as Beijing seeks to maintain a stable exchange rate. Officials also wish to project financial stability ahead of the Third Plenum, an important meeting of the Communist Party that is due to convene in November.
While the end of QE3 and subsequent capital outflows do pose a risk, Beijing has sufficient buffers to see off the worst of the problems felt elsewhere. Economies such as India and Indonesia with current account deficits and which are dependent on inflows of foreign capital “have borne the brunt of the adjustment” in global monetary trends, noted BBVA.
China stands to fare better. “[A] high savings level and conservative balance of payments give it a lot of room for economic restructuring” unlike other nations, Bank of America-Merril Lynch chief China economist Lu Ting said in a note published on Monday. The country isn’t forced to borrow abroad to pay for what it spends so therefore avoids associated currency risks.
Senior officials also have the ability to loosen domestic liquidity through their own means. Scaling back the amount of money banks need to hold in reserve injects more cash into the real economy, notes Lu. This is an oft-deployed monetary tool by the People’s Bank of China.
In some ways, the tightening of loose monetary policy by the Fed could be interpreted as a positive for China. Tapering QE3 will only come in tandem with an economic improvement in the US, which accounts for some 20% of Chinese exports alone. A stronger US economy could offset any declines in shipments to struggling big emerging markets that buy less than 15% of Chinese goods.