The International Monetary Fund in its Financial Stability Report released on Tuesday has said there’s no evidence of a bubble in emerging market assets so far. It says that relative risk perceptions between mature and emerging economies have changed because of the crisis and this has led to substantial portfolio flows to emerging markets. The favourable performance of emerging market assets relative to mature markets has led to global investors raising asset allocation to emerging markets. But have asset prices reached excessive valuations?
IMF thinks not. It says that the z-score, or deviation of current asset values from the historical average expressed in the number of standard deviations, is still less than 1.5 standard deviations for the vast majority of emerging markets. In the equity markets, for example, IMF says India’s valuations are 0.7 standard deviations higher than its average. Among emerging markets, 12-month forward price-earnings multiples exceed 1.5 standard deviations only in Brazil and Colombia.
Residential real estate prices, however, are stretched in Hong Kong, where price-rent ratios are 2.1 standard deviations higher than the average. In China, price-rent ratios are 1.9 standard deviations higher than the historical average. For India, the corresponding number is 0.2, showing no signs of a bubble.
Graphic: Naveen Kumar Saini / Mint
The report also says that the resumption of portfolio flows to emerging markets have coincided with some pickup in leverage. Hedge fund assets are now at about three-quarters of their pre-crisis peak, and while the incentives for the carry trade have improved, they have not yet reached the high levels of 2006 and 2008. As far as domestic credit goes, only China has seen explosive growth.
According to IMF, among emerging equity markets, only Brazil, Colombia and Mexico fall in the high valuation area, with valuations above 1 standard deviation over their historical averages.
But while there’s no evidence of an emerging markets bubble at the moment, it could very well happen in future. The report says that “some estimate that emerging market equities account for just 5-9% of global equity exposures, far lower than their share of global market capitalization of 12%, and the 27% share implied by a GDP-weighted global equity index”. That could mean higher allocations to emerging equities in future.
The report also points out that “even small shifts in portfolio allocations could translate into significant capital inflows to emerging markets and other advanced economies”.
And finally, it warns that the abundant liquidity that remains within advanced countries’ banking systems, if unlocked, has the potential to boost the prices of risk assets.
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