Ashmore’s Dehn says EM current account situation improving

7th October 2013

With markets obsessing about the current account balances – and deficits – of emerging markets fund manager Ashmore says the position has improved in some markets.

Ashmore head of research Jan Dehn is generally sceptical of the supposed crisis facing emerging markets due to QE. Indeed, he even suggests that emerging markets should be running current accounts deficits.

In a note issued this week, however, he says the position in improving in some markets listed below.

1.     Turkey’s trade deficit shrank to a lower than expected USD 7.0bn from USD 9.8bn in last month’s reading

2.     Brazil’s trade surplus came at USD 2.15bn versus USD 2.0bn expected

3.     India’s Q2 current account deficit at USD 21.8bn was narrower than the anticipated USD 23bn deficit

4.     Indonesia’s trade balance swung into a small surplus of USD 132m versus an expected deficit of USD 811m

5.     Malaysia’s trade surplus was the strongest in six months due to a 12.4% year on year surge in exports (versus 4.7% year on year expected)

6.     The big outlier was South Africa, where the August trade deficit widened sharply to USD 19.1bn from USD 13.4bn last release. South Africa’s trade balance is particularly sensitive to the relative prices of gold and oil, which have moved strongly in favour of oil lately.

Dehn asks why are the markets obsessed about current account deficits?

“After all, Emerging Markets ought to be running current account deficits and importing capital to finance investment spending in order to further their economic convergence with richer countries. The reason is that current account deficits can also be a sign of domestic imbalances or a misaligned nominal exchange rate.

“For example, for too long Indonesia maintained a quasi-peg with the US dollar which was inconsistent with the pace of domestic demand. The result was a steady widening of the current account deficit and an accompanying steady loss of reserves. Thus domestic imbalances beget external imbalances. No economies are permanently in equilibrium. Modest domestic and external imbalances are the norm in developed and emerging markets alike”.

Discussing various purchasing managers indices, he says: “Purchasing Managers Indices in developed economies appear to be leading PMIs in Emerging Markets by about a month in this particular cycle, so, in our view, it is reasonable to expect October to be another month of improvement in manufacturing”.

“Despite the traditional role of the manufacturing cycle as an indicator of the broader business cycle we are sceptical about reading too much into capital spending dynamics from the current manufacturing cycle. Indeed, since 2008/2009, upturns in manufacturing cycles have repeatedly failed to turn into sustained capex led recoveries. Six years into the crisis, corporate cash levels remain high, and capex spending remains subdued”.

“We think manufacturing cycles mainly reflect random shocks to demand and supply, or simply inventory corrections necessitated by inaccurate estimates of future final demand by purchasing managers. This means that the current pick up in the global manufacturing cycle is best regarded as a gentle and welcome tailwind, but not a development that is likely to unleash material and sustained changes in the global macroeconomic environment”.

Dehn adds that a shut down of the US government has had very little impact but a default would be far more serious.

“A failure to raise the debt ceiling – which has to be done by mid-October to avoid a default – would be far more serious, not least because Emerging Markets central banks are so heavily exposed to US Treasuries. The entire financial system, including its regulatory framework, is based on the assumption that US government debt is risk free.

“While a default would likely to be cured fairly quickly there would be costs beyond the initial dent to confidence. Borrowing costs for all Americans would probably rise. In an economy with debts in excess of 400% of GDP even modest increases in borrowing costs will hurt growth (as the collapse in mortgage applications over the summer showed). Fortunately, in the final equation, there is nothing that prevents the Fed from buying even defaulted securities. After all, it can just print some more money.”

Leave a Reply

Your email address will not be published. Required fields are marked *