When capital flows into emerging markets, regulators are faced with a dilemma: They could raise rates and get a foreign credit boom, or cut rates and have a domestic credit boom. They chose door number 2. So emerging markets had big domestic credit parties. That ended last May when Bernanke said the Fed would soon start drawing down QE. Hot money ran for the door, currencies dropped, and the weakness that had been there all along became obvious.
Source: Everything You Need To Know About the Emerging Market Currency Collapse
But the problem really is where the flows go. If they go into new business development, creating jobs and economic activity that eventually is self-sustaining then they are to be welcomed. But if they go into real estate and/or construction (whether housing or infrastructure), or into funding consumer or government spending, then they could be blowing up potentially damaging bubbles. So the challenge is to determine when inward flows are helpful and when they are not. And this is not easy for governments to do.
Source: Capital Controls or Cooperation
The raw facts are that a remarkable amount of money has been pulled out of EM with indecent haste; and that this was the first emerging market sell-off to be conducted mostly through ETFs. They now account for about $300bn of the $1.3tn in emerging market equities. The total pulled out exceeded the sums that exited during the 2008 crisis, even before emergency rate rises in Turkey, India and South Africa. Emerging market ETFs suffered redemptions of $4.4bn (4.8% of their assets) last week. Over the past three months, they have shed 15.8% of their assets.
Source: Emerging markets are badly served by ETFs
Should the US Fed cooperate with the EMs as it goes about tapering? They did not even mention EMs in their latest meeting. And it makes sense.
While more than half of the U.S.’s exports go to countries with developing economies, not all are in the same boat. Of the handful of countries with the worst troubles — large trade imbalances and tumbling currencies — only Brazil and India are significant export destinations. The U.S. sends 2.8% of its exports to Brazil, and 1.4% to India. U.S. companies get about 52% of their international profits from Europe. So overall, a recovery in Europe could outweigh any struggles from Asia or other developing markets.
Source: Emerging-Market Contagion? Think Again, U.S. Trust Says