The Great Asian Sell-Off

Why are investors suddenly fleeing markets in South and Southeast Asia?

Don't call it a crisis -- not yet, at least. Investors have been fleeing markets in South and Southeast Asia, and share values and currencies have been tumbling. But some of the drop might not reflect underlying changes in these countries' economies, so bargains may be there for the taking.

The dip in India's rupee has been grabbing headlines lately (including mine last week), but other currencies are on the rocks as well. The Thai baht has slipped by about 10 percent versus the dollar since April, and the Indonesian rupiah is about 12 percent lower. Of course, much of this trend stems from the strengthening of the dollar, with the U.S. Federal Reserve gradually ending its huge purchases of securities and slowing the expansion in the money supply.

Meanwhile, Indonesia's main stock market index has dropped by about 20 percent since May, and Thailand's is down about 17 percent. Stocks in the Philippines had lost 20 percent within a month of their peak in May, but now they have stabilized with losses of about 12 percent. Indian stocks have plunged by more than 10 percent just since July.

Dips in exchange rates and stock indexes don't always go together. All other things being equal, share prices might be expected to rise when currencies lose value. With no change in the real return to capital -- that is, the return generated by companies' assets, adjusted for inflation -- the price of a share to a foreign investor should remain the same. Indeed, these offsetting moves have happened to some extent in Japan under its new inflationary monetary policy; as the yen has slumped, the Nikkei index has shot skyward. (To be sure, the optimism generated by the new policy has helped stocks outpace the currency's decline.)

But this offset doesn't occur when foreign investors suspect that the return to capital is dropping; then the sell-off is all-encompassing. In Asia, investors are first selling their financial assets and then selling the proceeds -- the rupees, baht, rupiahs, and pesos -- for other currencies.

One nagging question arises in the midst of this havoc: Why dump all the countries at once? There's isn't just one explanation for the widespread destruction of value in Asia. Each country has its own issues, just as the crisis in the eurozone had causes that varied from budget deficits to bank failures. Indeed, global investors have supposedly gotten better at distinguishing between emerging markets, thanks to better transparency and access to information. The old fears of "contagion" in financial crises, which became especially notorious during the Latin American crashes starting in the 1980s and the Asian crisis in the late 1990s, have somewhat abated. Yet because many investors put large groups of emerging markets in the same boat, the markets must still sink and sail together.

Investors usually see emerging markets as risky, and on average they are: Corruption, conflict, weak property rights, and other problems are all more common in developing countries. Investors also tend to group emerging markets together in their portfolios, sometimes even combining enormous regions spanning whole continents. Fidelity's EMEA fund, for example, covers "emerging Europe," the Middle East, and Africa. By my count that's about 80 countries, and they could hardly be more diverse. What does Turkey's economic future have in common with Gambia's? Ask Fidelity.

Given this kind of bundling, consider what happens when one emerging market runs into problems, like the steep drop in forecasts for growth in India that I wrote about last week. If investors decide India is riskier than they thought, then they have to reduce risks elsewhere in order to maintain balanced portfolios; in fact, big investors like pension funds are often required to do this. And what's the easiest way to reduce risks? By getting out of emerging markets.

So when one emerging market gives fright to investors, they have a natural tendency to pull back from other emerging markets as well, even if the other markets have little in common with the one having problems. This seems unfair, and it is. Even in this era of unprecedented information and transparency, contagion still occurs, and it does so almost automatically.

It's true that countries in Asia are experiencing some common challenges in the short to medium term. China is a major source of demand in the region, and it has been growing more slowly of late. Japan is also an important trading partner for many of its neighbors, and forecasts for its growth are still anemic despite the country's new economic policy.

But it's hard to believe that the long-term growth paths of Asian countries have taken such a negative turn just in the past few months. The price of an Indonesian share to an American investor, for instance, should be proportional to the value in today's dollars of all the returns generated by the company from now until its dissolution. Has this total really dropped by more than 30 percent just since May? Or was it a bubble in the first place, inflated by hype and investors frustrated with low returns in the West? With an automatic pullback in emerging market portfolios, neither explanation can justify the sell-off completely.


Daniel Altman

If India's Really Booming, Why Is the Rupee Crashing?

Meet the banker who could save the country's faltering currency.

How the mighty have fallen! Look where the supposedly world-beating BRIC countries are today: Brazil is mired in protests, China's growth is slowing, Russia is addicted to self-destructive spy games, and India's currency is at an all-time low. Of the four, India has the brightest prospects for growth ahead, so why has the rupee taken such a dip?

Even though China is growing faster right now, India has many more years of rapid expansion ahead simply because it hasn't urbanized or adopted new technologies to the same extent. You'd think foreign investors would be desperate to get in on the ground floor of this long-term boom, but naturally they're more fickle -- and less patient -- than that. And since the value of the rupee in global markets depends on their demand as well as its supply, you have to consider both to understand what's happening.

On the demand side, the key is to think about why people might want to exchange other currencies for rupees. Buying anything from India -- goods, services, financial assets -- can require rupees. When demand for any of these things rises, so does demand for rupees. Of course, when the rupee gains value, anything bought with rupees becomes more expensive for foreigners, so demand may equilibrate on its own.

That hasn't happened yet for Indian assets. In April 2011, the International Monetary Fund forecast that India's economy would grow by a total of 37 percent from 2013 through 2016. The fund's latest prediction, updated last month from the April 2013 figures, is for growth of just 28 percent in the same four-year period. It goes without saying that less potential for growth means less interest from foreign investors.

At the same time as India's growth forecasts were falling, other markets were becoming more attractive. A few years ago, investors frustrated with the slow recoveries in established markets might have taken a risk in India. Now, with a backdrop of somewhat greater stability, investors are returning to the advanced economies to hunt for bargains and ride the cresting wave. Not surprisingly, credit is tougher to come by in India; the yield on its government bonds has hit a five-year high.

The jump in bond yields may also have to do with expectations for inflation, which is another concern in India. As prices climb, the value of the rupee in real terms falls, and investors won't give up as much of their own currencies to buy it. Consumer prices rose by only 3.8 percent in 2004, but the rate quickened in every subsequent year through 2010, when it hit 12 percent, one of the highest rates in the world.

With inflation still at 9.3 percent last year and possibly higher in 2013, the new governor of the Reserve Bank of India (RBI), Raghuram Rajan, has his work cut out for him. His job is to decide the supply of rupees, and by slowing the printing presses he could stem inflation. Yet by curtailing access to credit even further, he could also cool the economy, and not at a good time. India's leaders are already starting to worry about next year's elections, and the RBI is much less protected from their meddling than the Federal Reserve or the European Central Bank.

That said, there is certainly room for improvement on the supply side. Between July 2011 and July 2013, the Indian money supply increased by about 29 percent. During the same period, the value of India's gross domestic product in rupees probably increased by about 27 percent. In other words, the RBI let the money supply expand by more than the amount necessary to cover inflation and economic growth; the extra rupees dumped into the economy were just more fuel for the inflationary fire. The bank may have made the money available to help foreigners purchase Indian assets, but by cheapening the rupee it may actually have driven them away.

In the longer term, the rupee should be able to tolerate moderate inflation without losing more of its value. The productivity of Indian workers is indeed increasing as the country urbanizes and adopts new technologies. Wages will rise, and so will prices. With a higher price level, anyone selling a unit of Indian stuff will receive more rupees for it. Barring a big change in the exchange rate, more rupees will buy more foreign currency, and more foreign currency will buy more foreign stuff. None of this would necessarily preclude equilibrium in the supply and demand for rupees.

So what's the endgame here? As long as the RBI doesn't start printing rupees like there's no tomorrow -- and with Rajan in charge they almost certainly won't -- the currency's freefall will be temporary. At some point, Indian assets, goods, and services will seem cheap, and buyers will return.

But for that to happen, the currency markets must be left to their own devices. The pre-Rajan RBI has moved in the opposite direction by limiting Indians' ability to sell rupees, which investors will interpret as a last-ditch effort to maintain the currency's value at an artificially high level. In Argentina, similar measures recently led to a black market in pesos and further undermined confidence in the country's economic policies. For Rajan, reversing course will be job one.