Given that many emerging market countries rely on exports to power their economic growth, a current account deficit (more imports than exports) can be particularly troubling for investors. In this scenario, the emerging economy is increasing its liabilities to its trading partners (through balancing financial account flows) that will eventually need to be repaid. During periods of market stress, investors become concerned about these deficits and reduce their exposure. This can have a particularly strong effect on the price of assets and the value of the currency. As investors sell assets and convert the currency to U.S. dollars, simple effects of supply and demand decrease prices and weaken the currency.
Yet for all the focus on emerging markets, the country with the largest current account deficit in the world is the United States! Also, Australia and New Zealand have been able to run current account deficits equivalent to 5% of GDP for the last 20 years.1 Indeed, developed markets seem to be held to different standards. However, developed markets tend to have higher savings rates than developing economies and, generally, are much less likely to be as reliant on foreign capital to finance these trade imbalances.
But reverting the focus to a topic we’ve discussed multiple times before, not all emerging markets are created equal. In addition to where they fall along the development continuum, EM countries also have varying degrees of external vulnerability. The countries that seem to have come under the most pressure so far are India, Indonesia, South Africa and Turkey. While each country’s causes and positioning tell their own story, the market is focusing on these countries’ current difficulties and extrapolating those challenges to essentially all emerging markets. In our view, although they may currently face headwinds, we believe that each of these countries will eventually correct course.
Maintaining Perspective
As emerging markets continue to evolve, it is important to have an investment process in place that is capable of evolving with the market. In our view, looking to a single data point doesn’t provide the necessary context to identify a potentially destabilizing trend. Looking at supporting evidence and more recent, market-based factors can also be beneficial when attempting to make investment decisions. While focusing on macroeconomic fundamentals may not always lead to investment gains in the short term, we believe that vigilant monitoring of external vulnerabilities can ultimately lead to a more intuitive approach to investing in emerging markets.
Rick Harper is head of fixed income and currency for WisdomTree Asset Management. This post was republished with permission from the WisdomTree blog.
1Source: International Monetary Fund (IMF), April 2013.
