Emerging markets ended the quarter with positive returns, with the MSCI Emerging Markets index gaini...
Emerging markets ended the quarter with positive returns, with the MSCI Emerging Markets index gaining 12.1% (as at 31 March 2006) in dollar terms. Strong performances were seen across the emerging markets universe, where some markets recorded substantial returns while others saw small gains.
In Asia, top performers included China, India and Indonesia. However, political turmoil in South Korea and Thailand adversely impacted financial markets. Most Latin American markets recorded double-digit returns during the three-month period as investors remained positive on the region's recovery.
The Russian market recorded the strongest gains in Eastern Europe as investors continued to be drawn towards the country's strong economic growth, strengthening finances as a result of high commodity prices, and stable political environment.
South Africa continued on an upward trend, while uncertainty regarding Turkey's monetary policy rattled investor confidence.
Emerging market countries have learned their lesson since the Asian monetary crisis in 1997-1998. Then, the countries most hit had all borrowed dollars aggressively and so were exposed to a domino effect when their local currencies fell.
Emerging market countries are now beginning to borrow in local currency rather than issuing exclusively in US dollars and even those issuing dollar-denominated bonds are paying low interest rates.
In addition, many countries have built up such huge foreign reserves it is easy for them to pay off their debts. Despite its reputation as a bad payer, even a country like Argentina is back in the issuance market. It also runs a budget surplus. As a result, spreads over T-bonds have declined to such an extent that many bond investors are asking themselves why they should buy dollar-denominated bonds rather than local-currency ones that offer much better returns for a reasonable level of risk in view of the performance of these countries' currencies, their budget situations and their foreign reserves.
Countries like China, Japan and Russia all have a vested interest in ensuring that the US economy remains healthy. But if the perception of the US and its ability to pay its debts turns so uniformly negative that investors rush for the door, then it would have a disastrous affect on all concerned.
Longer term, one can hope that countries like China and India will become self-sustaining, with their economies less dependent on exports and more geared to expansion in domestic consumption.
Already the large Asian countries are becoming engines of regional growth in their own right. Taiwan and Korea for example already export more to China than to the US.
Hedge funds have also been playing an important role in controlling volatility in the emerging markets because they help to provide a sense of balance in these countries. They supply a lot of liquidity, but at the same time they are not afraid to short markets.
Of course this is how the market works in normal conditions. In abnormal conditions you could see tremendous volatility in one market accentuating hedge fund movements in emerging markets in general and potentially leading to panic throughout the emerging markets.
China, Indonesia and India performing well
Russia supported on the back of high oil prices
Argentina now running a budget surplus
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