Bank of America Merrill Lynch has a report out titled “Pig in the Python – The EM Carry Trade Unwind” that makes for some interesting reading. The authors believe that most of the emerging markets “story” is just that – a story. Investors are mistaking waves of capital inflows into EMs with intrinsic growth:
There are many ebullient investment ideas we have heard over the past 25 years: the massive infrastructure theme, the growing middle class, the nutrition/water idea, the urbanization meme, the emergence of this sub-region or the other. We remain skeptical and cynical. Eventually, these glossy investment views have run into tighter global monetary conditions, the inevitable crises, large capital losses and vows of “never again”. Until, of course, the next global monetary easing, when all is forgiven, and a fresh wave of investors wades in again.
Whenever DMs enter an easing cycle, a carry trade ensues where EM corporates and banks go on an international debt binge. But once DMs start tightening, the tide goes out.
This sort of unwind typically hits banks first – especially those who don’t have a wide deposit base. And once banks start sneezing, the rest of the economy catches a cold. But surprisingly, Indian banks actually slowed down their external borrowings post-QE:
As QE gets tapered and the carry trade unwinds, spreads on most of this debt are going to widen and asset prices will deflate. It looks like China and Thailand are in for a pretty rough ride.
Related articles
- Emerging Markets Too Quiet? (blogs.wsj.com)
- Emerging Markets at Risk From Carry Trade Unwinding, BofA Says – Bloomberg (bloomberg.com)
