What’s good for U.S.-China-Japan hurts emerging markets

‘Incipient Recovery’

“Rather than being a sign of incipient recovery, a sudden spike in bond yields might be enough to send some economies off the rails altogether,” said King, adding that the U.S. may suffer a backlash if trade dries up as a result.

Policy makers are pushing back in the hope of persuading markets to refocus on the weakness of their economies. Mark Carney, who became governor of the Bank of England on July 1, and European Central Bank President Mario Draghi both signaled last week that they will keep interest rates low for longer than investors anticipated.

The prospect of less U.S.-led stimulus also is rocking emerging markets. Particularly prone are economies that took advantage of easy money to run up current-account deficits and borrowing imbalances, according to Michael Saunders, a Citigroup Inc. economist in London. Outside of China and the Middle East, emerging economies have aggregate current-account shortfalls of about 2% of GDP, the highest since the late 1990s.

Disappearing Surpluses

Thailand and China are among nations whose surpluses have shrunk, while Indonesia and India face mounting deficit challenges. Gaps in Chile and Brazil also have grown. Meantime, average private-sector debt in South Korea, Thailand, Singapore and Indonesia has risen by 25 percentage points of GDP in the last four years, according to Citigroup.

China, Hong Kong and India are in a “high-risk danger zone” if a pullback by the Fed prompts investors to punish Asian countries that have weak economic fundamentals and are too slow to reform, according to a June 28 report from Nomura Holdings Inc.

In Europe, Hungary and Poland are at risk because foreign investors have large holdings of local-currency debt, according to Oxford Analytica, based in Oxford, England. Turkey is especially vulnerable because of its reliance on foreign cash to finance its large current-account gap at a time when political tensions are rising, the consulting company said in a report last week.

Worsening Fundamentals

“Many emerging-market countries now face the long-absent challenge of rising capital needs with worsening fundamentals at a time when global-liquidity conditions may not be easing further,” said Citigroup’s Saunders.

That already is forcing a response as authorities from Brazil and Thailand to India and Indonesia raise interest rates, intervene in currency markets or unwind capital controls to stanch the exit of cash or limit its fallout. In doing so, they’re reversing some of the measures introduced to cope with the hot money sent their way by the loose monetary policies of recent years.

China is also in transition as its policy makers seek to rein in financial speculation and real-estate prices, signaling tolerance of a weaker expansion. Interbank borrowing costs reached records on June 20 before easing.

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