Recent Research/Publications

Decoupling’s Two Sides

While the media (and international financial institutions) continue to hype the “de-coupled” theory about emerging markets, which argues that even if the US falls into recession, the emerging markets will continue to grow strongly, investors have mixed views. For emerging market debt buyers, US rate cuts make both hard and local currency offerings more attractive and the falling dollar is expected to continue to attract significant interest in local debt markets. However, despite the USD 7 billion raised by sovereign and semi-sovereign issuers in the first full week of 2008, analysts agree that with the ongoing liquidity crunch, it may be still be difficult for emerging market borrowers to come to market and even with access rates will be higher. While investors generally agree that to date the de-coupling has worked, several noted that during the most volatile periods in recent months, unwinding of yen carry trade positions did highlight individual country’s vulnerabilities, as those with the biggest external imbalances saw heavy sell-offs.

For stock market investors, continued high commodity prices and good growth in the emerging markets is largely seen as supportive for the asset class this year. However, investors expressed concern about the impact of rising global inflation as well as the possibility that the entire G-3 could fall into recession which could derail both the commodity bull-run and emerging markets exports.

A key message on the popular de-coupling theory is that continued good growth and performance across the asset class depends on the developed world, with attention focused on growth, inflation, and the credit crunch. At the same time, however, individual countries – notably in emerging Europe – could experience their own sub-prime crises, but most analysts expect that contagion would be limited.

With the mixed view of investors on the de-coupling of emerging markets from developed ones, all agreed that recent volatility is expected to continue in the coming months and expect that 2008 will be even more difficult. Investors expect continued short-term spikes in risk aversion that will rock the markets and currencies in countries with external imbalances, including the Baltics, Balkans, Hungary, Turkey and South Africa. In 2008 the flow of funds to the “uncorrelated” markets in the Middle East and Africa is expected to continue to pick-up. Already a flurry of funds have been launched targeting Africa, and further market opening in the Gulf is expected to attract fresh inflows, further buoying current account surpluses.

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