Simon Kennedy and Bill Faries, Bloomberg
Paris/Buenos Aires: Vietnam’s stock market, among the world’s top performers this year, is triggering concerns that shares may be in for a fall. Brazilian and Colombian exporters are struggling to compete as the value of their currencies mounts. Residents of Latvia’s capital, Riga, have seen house prices jump 67% in a year.
Overseas investment will flood emerging markets with $469 billion (Rs19,09,768 crore) this year, according to the Institute of International Finance in Washington. That will bring the total since 2005 to almost $1.5 trillion, twice as much as in the prior three years. While fueling growth, all that cash is bringing side effects that threaten to turn booms into busts.
“This is the cost of success,” says Claudio Loser, a former International Monetary Fund official now at the Inter- American Dialogue in Washington. “It creates problems.”
Latvia and Romania may be in for hard landings, and big current-account deficits pose a threat to the investment outlook for Bulgaria and Estonia, Standard & Poor’s said last month. The IMF warned about Vietnam in March.
“There is somewhat of a bubble element to all of this,” says Desmond Lachman, a resident fellow with the American Enterprise Institute in Washington. “The world is fraught with risks right now.”
Behind the Explosion
Behind the explosion in overseas investment: The strongest global expansion in a generation and the ability to borrow at near record-low interest rates in markets such as Japan and Switzerland. Those forces are drawing money into economies whose low-cost labour and increasingly valuable commodities offer opportunities for higher returns.
To be sure, foreign capital brings benefits by generating growth, tax revenues, employment and infrastructure improvement. In Turkey, record overseas investment triggered growth of 6.1% last year and, by boosting the lira, slowed inflation enough to satisfy the terms of a $10 billion loan agreement with the IMF. Foreign money cushioned the fall in Turkish stocks last month after the army intervened in the presidential election.
“Turkey welcomes and encourages foreign investment,” says Inan Demir, an economist at Istanbul-based lender Finansbank AS. “It helps growth, and a strong lira supports the disinflation programme.”
The challenge comes in managing the flow of money. Let it rip, and so do inflation, asset prices and currency values. Choke it off, and the good times may come to a swift end. “You see an overheating in a number of emerging markets,” says William Rhodes, senior vice chairman at Citigroup Inc. in New York. “There’s a lot more sensitivity to taking steps to avoid a meltdown.”
Governments around the world are now trying to strike the right balance as they realize foreign cash can be too much of a good thing.
Thailand last year went too far and had to backtrack when its stock index sank the most in 16 years after curbs were imposed on foreign investments. “Capital controls are very drastic because they can have a very negative impact on investment and the economy,” says Irene Cheung, an economist at ABN Amro Bank NV in Singapore.
“The sheer volume of trade and capital inflows is getting harder to absorb and is causing distortions,” says David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York.
China, the biggest emerging market, is struggling to curb overinvestment in factories and real estate projects, while seeking to limit appreciation of the yuan. Central bank Governor Zhou Xiaochuan on 6 May expressed concern that a bubble is building in the nation’s stock market, which has rocketed more than 80% so far in 2007.
Concerns extend well beyond China, which will account for roughly a fifth of the private capital flowing into emerging markets this year, according to IIF figures.
In Latin America, the biggest distortions tend to be in currency values, as rising demand for commodities including copper and soybeans attracts more money from abroad. Colombia’s peso has shot up 10% this year, the second-biggest gain among 71 currencies tracked by Bloomberg, and Brazil’s real has risen almost 6%.
Pain for Exporters
That’s causing pain for the region’s exporters, such as Colombian banana and flower growers. Brazilian shoemaker Sao Paulo Alpargatas SA has been forced to cut jobs as it’s been priced out of export markets.
Brazil’s government has tried to limit the real’s rise by changing tactics to make its sales of the currency less predictable. Colombia’s central bank on 6 May announced lending limits on banks to curb what President Alvaro Uribe calls “speculative” capital inflows.
Central banks in eastern Europe are grappling with inflation as foreigners invest in building plants and buying property in countries joining the European Union.
Latvian consumer prices are accelerating by the most since at least 2001, while property prices in Bulgaria have surged 60% over the past two years.
“The prospect of increased investment flows brings with it the possibility of economic overheating,” says Ana Mates, a credit analyst at Standard & Poor’s in London.
The challenge may be most difficult in Asia, where central banks are wrestling with both inflation and appreciating currencies at the same time.
That puts them “on the horns of a monetary-policy dilemma,” says David Simmonds, global head of currency research at Royal Bank of Scotland Plc in London. While central banks need to tame price pressures, doing so through higher borrowing costs draws more money from abroad and pushes up exchange rates.
In India, where the rupee is near a nine-year high, the price of yellow peas, a staple, has shot up 35% in six months. Inflation has exceeded the central bank’s 5% target since September, even after 2 1/2 years of interest-rate increases. Instead of discouraging lending, those rate increases only raise “the possibility of further capital flows,” says Reserve Bank of India Governor Yaga Venugopal Reddy, who has introduced lending curbs.
Elsewhere in the region, the Philippines central bank last week began offering pension funds and some state companies the chance to deposit money in higher-yielding accounts in order to curb the money supply. The flood of overseas investment in Vietnamese stocks prompted the country’s central bank to consider controls on capital flows.
In such a climate, “there are vulnerabilities out there,” says Tim Ash, emerging markets analyst at Bear Stearns & Co. Inc. in London. “There’s no doubt that at some point there will be corrections. You don’t want to be the last out of the door.”
— With reporting by Fabio Alves in Brasilia, Adriana Brasileiro in Rio de Janeiro, Eliana Raszewski in Buenos Aires, Andrea Jaramillo and Helen Murphy in Bogota, Matthew Walter in Santiago, Milda Seputyte in Vilnius, Shamim Adam in Singapore, Cherian Thomas in New Delhi, Kathleen Hays in New York, John Fraher in London, Louis Meixler and Steve Bryant in Prague, Zhang Dingmin in Beijing, Rich Miller and William McQuillen in Washington, Elizabeth Konstantinova in Sofia, Adam Brown in Bucharest, Matthew Brown in Dubai, Aaron Eglitis in Riga, Balazs Penz in Budapest, Radoslav Tomek in Bratislava, and Margo Towie in Bangkok