ING IM warns of downgrade to emerging markets outlook

Valentijn van Nieuwenhuijzen, head of Strategy at ING Investment Management, has warned that increasing risk surrounds emerging markets investments, and that the poor outlook could result in a downgrade for the asset class.

The manager said it has cut its exposure to EM assets. Reasons include macro policies not improving in countries with current account challenges; equity fund flows turning negative; surveys pointing to investor overweights in EMs; and a widening risk gap between the BRIC countries and the US.

Cyclical trends are struggling to keep up with signs of improvement in markets such as the US, Japan and Germany, while the depreciation of the yen makes it harder for EM exporters such as South Korea and Taiwan.

Trends are also developing that could put pressure on flows to emerging market debt markets – the so-called search for yield.

Van Nieuwenhuijzen (pictured) said: “So far, the rising external financing requirements of emerging markets have been met by strong portfolio investment flows into debt instruments. With foreign direct investment and equity flows clearly lower than the averages of the past five or ten years, the financing of the larger emerging market current account deficits has relied primarily on debt flows. We are getting increasingly worried about this because the improving situation in the developed world will have a negative impact on flows from developed into emerging markets, and also because of poor macro policies in some of the key emerging market countries. We are particularly concerned about India, Indonesia, South Africa and Turkey.”

ING IM said that India, Indonesia, South Africa and Turkey are the countries where the dependence on foreign capital has been the highest recently. Their current account deficits have been either high or rapidly increasing towards uncomfortable levels.

In Indonesia, the deterioration has see the country move from a small surplus in 2011 to a deficit of 3% in 2012. In Turkey, there has been an improvement from 10% in 2011 to 6% last year. In India, the deficit has not changed much in recent years, but a 5% current account deficit in combination with a structurally high fiscal deficit of 6% remains a concern. South Africa probably has the most negative picture, with a rapidly widening current account deficit (by 3 percentage points in the past year to 7%) and a ‘sticky’ budget deficit of 5%, ING IM said.

Van Nieuwenhuijzen said: “Given their large macro imbalances, the currencies of these four markets remain vulnerable to a sharp correction. All four countries rely heavily on speculative inflows. India and South Africa have large structural deficits and need a political breakthrough to tighten economic policies and carry out structural reforms. At this point, it is difficult to see much progress in the coming years. Turkey looks better, because the fiscal accounts are in good shape, and the current account deficit has been narrowing. Here, it is the large energy import bill that keeps pressure on the balance of payments.”

ING IM believes Indonesia is the country with the best macro fundamentals: a low external debt ratio and both fiscal and current account deficit still at a reasonable 3% of GDP. Also, foreign direct investment represents 60% of the current account deficit, which makes the country less dependent on portfolio inflows than the other three. But the rapid widening of the deficit and a lack of willingness to tighten policies ahead of next year’s elections make Indonesia more vulnerable.

ING IM has downgraded emerging markets from a small overweight to neutral, citing a number of reasons. These include relative fundamentals against other asset classes, earnings momentum data lagging developed markets, and CDS data suggesting a growing gap between the BRICs and the US.

ING IM also said it saw a reduced impact of industrial commodity prices, stemming from suggestions that China is looking to cool its property market.


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