During the boom years, emerging market governments were buying up foreign currencies left and right, but now emerging markets and their exchange traded funds (ETFs) could be at risk from the deluge of foreign cash.
Investments from overseas inundated emerging markets with $469 billion this year, which brings it to a total of $1.5 trillion since 2005, or a record twofold compared to prior three years, reports Simon Kennedy and Bill Faries for International Herald Tribune.
The strong global expansion allowed for borrowing at interest rates near record lows, which poured money into economies with low-cost labor and valuable commodities that showed prospects of high returns. Foreign capital allowed for such benefits as generating growth, tax revenues, jobs and infrastructure.
The problem was finding the balance between inflation, asset prices and currency value against the benefits of foreign capital.
Edward Seaga for Jamaica Gleaner offers a plan for an emerging market country. He writes that by increasing interest rates, it would discourage the locals from buying foreign currencies to invest in overseas accounts.
It is cautioned that if the country does not meet local demand for foreign exchange, then the exchange rate will be pressured into a rolling fall, right out of the rate. For small countries, pegging the exchange rate would result in no speculative flight of foreign exchange.
Credit controls on lending could also be implemented in limiting the imports of foreign goods beyond the current limits so as to prevent a drain on reserves.
It is noted that foreign-exchange reserves in several countries have shrunk over the last year, according to Economist. The diminished reserves are likely caused by commodity prices, previously a big cash cow for emerging markets, and the currencies of emerging countries that are now under pressure.
Problems in the emerging market countries may adversely affect ETFs such as:
- iShares MSCI Emerging Markets Index (EEM): down 51.6% year-to-date
- Vanguard Emerging Markets Stock ETF (VWO): currently down 54.9% year-to-date
- PowerShares MENA Frontier Countries (PMNA): currently down 50% since its July 22nd inception