If a shock were to hit Brazil, India, Indonesia – or any other emerging market country – tomorrow, how would investors react? Would asset values adjust smoothly, amid an explosion of trading flows? Or would markets instead freeze up, as liquidity evaporated?
It is not an academic question. Earlier this year, when investors started to speculate about an American “taper” – or wind-down from quantitative easing – this conjecture was enough to spark a dramatic gyration in the value of some emerging market assets, such as Indian or Brazilian equities. Since then, those markets have more than recovered. And with most economists still believing the taper remains many months away, investors expect this rally to continue. But behind the scenes, as the private debates in October’s meeting of the International Monetary Fund indicated, some policy makers and asset managers are getting uneasy.
For the real problem with emerging markets today, policy makers admit, is not simply that reform has slowed in places such as Brazil, or that growth rates have disappointed since the 2008 crisis. Nor is it simply that some emerging market countries have experienced spectacular capital inflows – and could thus suffer economic pain if these reverse.