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Economic Commentary
QNB Economics
economics@qnb.com
4 October, 2015
Dovish Fed offers limited respite for EMs
Emerging Markets (EMs) have continued to
suffer from capital outflows, even after the
Federal Reserve (Fed) decided not to increase
interest rates on 17th
September (as we
predicted in a previous commentary, Markets
could tilt the Fed towards postponing its rate
hike). All else being equal, lower US interest
rates would have been expected to slow capital
flows away from EMs by maintaining the
interest differential between EMs and
developed markets (DMs). Lower US rates
should also reduce the debt burden of EM’s
USD denominated debt as they should lead to
a weaker USD. The fact that capital outflows
have continued even with the dovish Fed,
suggests that concerns about EMs are more
deep-seated. Investors are also worried about
structural economic weaknesses in a number
of EMs, such as slowing growth, falling
commodity prices and rising credit.
Monthly Debt and Equity Flows into EMs
(USD bn)
Sources: Institute of International Finance (IIF) and QNB
Economics
Recent data on capital flows, exchange rates,
equity markets and sovereign yields, all
suggest that capital flight from EMs has picked
up since the Fed decision not to hike on 17th
September. First, the IIF produces data on
daily debt and equity portfolio flows from
seven EMs (Indonesia, India, Korea, Thailand,
South Africa, Brazil and Turkey). Although
these EMs received net inflows on the 17th
and
18th
of September of USD800m, suggesting
some relief at the Fed decision, this amount
was soon swamped by net outflows from 21st-
30th September totalling USD2.9bn. Second,
exchange rates in nearly all major EMs
weakened significantly against the USD.
During 17th
-30th September, the Brazilian real
fell 3.1%, the South African rand fell 4.4% and
the Malaysian ringgit fell 3.7%. The notable
outperformer was the Indian rupee which
strengthened 1.3%, giving the Reserve Bank of
India room to cut interest rates by 50 basis
points (more than the 25bps expected) on 29th
September. Third, equity markets in almost all
EMs have fallen since the Fed’s
announcement—Brazil is down 7.2%, South
Africa 1.6% and Russia 5.1%. Overall, the
MSCI EM equity index fell 3.7% over the
period. Fourth, sovereign yields have risen in
most major EMs, up 37bps in Brazil, 36bps in
Turkey and 7bps in Indonesia, for example.
Overall, the spread of EM bond yields over DM
yields widened by 54bps as capital flowed out
of EMs and into safe havens.
There are a number of structural economic
reasons that capital flight from EMs has
continued despite the Fed’s decision to keep
rates on hold. First, EM GDP growth forecasts
have been steadily revised down this year as
activity has slowed. The Fed even pointed to
slowing global growth as a reason for not
increasing rates, which may have heightened
investor concerns, especially in EMs. Second, a
number of EMs are commodity based
economies, which have been hit by the
collapse in oil and other commodity prices
since mid-2014. Countries such as Brazil,
Indonesia and South Africa have all suffered
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2. Page 2 of 2
Economic Commentary
QNB Economics
economics@qnb.com
4 October, 2015
from a heavy dependence on commodity
exports. Third, rising corporate debt (~15% of
it denominated in USD) is becoming an
increasing drag on growth. EM non-financial
corporate debt more than quadrupled from
USD4tn in 2004 to USD18tn in 2014. The IMF
recently warned that corporate defaults are
likely to increase, especially if the Fed hikes
rates, leading to even slower EM growth.
China is at the centre of EM woes. Incoming
data on China have pointed to slower growth.
The devaluation of the yuan destabilised
global financial markets in August and
heightened concerns about the seriousness of
China’s economic problems. Slower Chinese
growth means less regional demand,
impacting a number of Asian EM exporters. As
the world’s largest consumer of most
commodities, slowing growth in China has
also pushed down commodity prices,
negatively impacting commodity-based EMs.
Finally, China is also responsible for a large
share of the increase in EM corporate debt—
total bank, household and corporate credit in
China has grown rapidly to reach USD21tn, or
over 200% of GDP. At some point,
deleveraging in China and other EMs is
inevitable and is likely to drag on growth.
So with China expected to slow further and a
Fed rate hike still on the horizon (widely
expected in December), the outlook for EMs
remains murky. Higher US interest rates will
lead to tighter financial conditions in EMs,
with some EM central banks likely to be forced
to raise policy rates to combat capital
outflows. Combined with moderating demand
from China, growth is, therefore, likely to
continue slowing going forward, leaving EMs
vulnerable to further capital flight, weaker
exchange rates and underperforming financial
markets.
QNB Economics Team:
Ziad Daoud
Acting Head of Economics
+974-4453-4642
Rory Fyfe*
Senior Economist
+974-4453-4643
Ehsan Khoman
Economist
+974-4453-4423
Hamda Al-Thani
Economist
+974-4453-4642
Rim Mesraoua
Economist – Trainee
+974-4453-4642
* Corresponding author
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