If emerging markets crash, will it be the US contagion or home-grown?

Are emerging markets immune from the issues affecting the US or will they be caught in another epidemic—or will the infection perhaps come from another source?

In 2008, when the US stock market crashed, the markets in emerging market countries went down as well. The US stock market has been crushed; first, because of the irresponsible attitudes of its legislators and now because of the possibility of the feared double dip. In contrast, the economies of many emerging markets seem very healthy. In the past the expression was that when the American economy sneezed, the world caught a cold. Are the emerging markets immune from the issues affecting the US or will they be caught in another epidemic or will the infection perhaps come from another source?
The problem with the question is that it makes many assumptions that are incorrect. One of the first assumptions is that the US economy will have an impact on the economies in emerging markets. If we exclude the European Union, the US is still the largest economy in the world. Obviously if the US goes into recession, global demand will decline. But the question is who does that affect and how much?
It would definitely affect the US's main trading partners, but those trading partners are generally not emerging markets. The US's largest trading partner is not Brazil, Russia, India or China. It is Canada. China is the second largest partner as is Mexico, but most of America's trade goes to G7 countries including Germany, Japan, France and the UK. Brazil is a large trading partner, but its total trade with the United States is slightly more than the US's trade with the Netherlands.
China's largest trading partners with the exception of the US and Germany are in Asia. India has a similar profile. The main difference is that some of India's largest trading partners are Middle Eastern oil exporters. The trade that is most important to the emerging markets is not with the US, but with other developing countries. This is especially true for the inter-Asian trade.
We also tend to assume that the world is so connected that problems in the US will carry over to other countries. This also depends on a few factors. Germany and South Korea are major exporters. Over 40% of their GDPs are dependent on trade. Again, both are large trading partners with the US, so a slowdown in America would definitely affect these countries. But others like India and Brazil are not. Only 15% of their GDP is related to trade. The US is even less. It averages about 10% of its GDP. China, the workshop of the world, is heavily dependent on global trade. Just under 30% of its economy is based on trade. So although the US economy is large, it trades mainly within North America.
There is a big difference between the economies in emerging markets and the equity markets in emerging markets. Equity markets in emerging markets are not necessarily accurate reflections of the underlying economies. Often these markets are quite small. Large parts of these markets by capitalisation may be represented by a single sector and often by a few companies. These markets are also heavily dominated by state-owned companies. Added to these issues are problems with liquidity, market manipulation and poor quality of information.
The recent rise of many of these markets has been due in part to the loose monetary conditions across developing countries as much as the growth of the local economies. The huge tide of 'risk on' foreign capital chasing yields may be more important. A 'risk off' trade could devastate emerging markets regardless of the state of their economies.
So if the growth of the US economy stalls, the effect in emerging markets would be felt, but it would not have the impact of 2008. This does not mean that these markets are safe. The difference is that the problems are within the emerging markets themselves. All of these markets are overheating. According the The Economist's emerging markets overheating index, the economies of Argentina, Brazil, India, Indonesia, Turkey and Vietnam have real problems. Almost all emerging markets have raised interest rates some many times. Brazil has raised them five times. India has raised interest rates 11 times. China has raised them 5 times. Many emerging markets are desperately struggling with inflation. Besides all emerging market economies tend to be unstable due to corruption, weak infrastructure, legal uncertainty and political infighting.
Credit bubbles are starting to appear particularly in Brazil and Turkey. The Chinese real estate bubble has been much discussed, but real estate prices are also at new highs in India and Brazil. Some equity markets have pulled back, but Indonesia recently hit a new high. If one BRIC falls, the panic could easily spread to all of the other emerging markets. The American economy is certainly not healthy, but unlike the emerging markets, it does not have a long way to fall.

(The writer is president of Emerging Market Strategies and can be contacted at [email protected]  or [email protected].)

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