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Emerging Market Rout May Signal ‘Sudden Stop’: Cutting Research

Brazil, South Africa, Turkey and Ukraine are the emerging markets most at risk of a “sudden stop,” in the view of Morgan Stanley.

That’s defined as a halt or even a reversal in capital flows into a country, slashing access to international financial markets for an extended period and weakening the economy. The term is often linked to 1995 work by Rudi Dornbusch, the late international economics professor at the Massachusetts Institute of Technology in Cambridge.

Mexico, Indonesia, India and Thailand are also in some jeopardy of such a phenomenon as investors turn sour on emerging markets, London-based economists Manoj Pradhan and Patryk Drozdzik said in two reports to clients over the past week. They wrote as central banks in India, Turkey and South Africa raised interest rates to shore up confidence in their currencies.

The Morgan Stanley authors evaluated the risk by looking at factors such as the reliance on capital inflows and credit, the size of the current account deficit, the legroom for policy and exposure to China. In the case of Brazil, for example, capital inflows account for almost half the money entering the country, total external debt is more than the size of foreign exchange reserves, the current account shortfall is almost 4 percent of gross domestic product, inflation is around 6 percent and government debt is about 70 percent of GDP.

The countries most in danger now face questions over how they will fund their budget and trade gaps and whether they can pivot to new sources of expansion, the economists said. Investors should monitor the processes of reducing debt and political splits. Ukraine, Turkey and Thailand have all witnessed social unrest.

“While the risk of a sudden stop is higher in some economies and lower in others, EM economies remain exposed to the risk,” Pradhan and Drozdzik said in a Jan. 27 report. “If policy makers don’t enforce the change and reforms that are needed to generate a new model of growth, asset prices will adjust by as much as is necessary to generate that change.”

In a Jan. 29 report after the rate increases in Turkey and South Africa, Pradhan and Drozdzik wrote: “this new policy awareness is by itself a positive and a step in the right direction.”

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The euro area is the major economy most at risk from the recent outbreak of emerging-market anxiety.

The region last year exported the equivalent of 3.1 percent of gross domestic product to Brazil, India, Indonesia, Russia, South Africa and Turkey, the countries most attacked by investors lately, according to Julian Callow, chief international economist at Barclays Plc in London. That compares with 2.4 percent for Japan and 1.3 percent for the U.S.

By contrast, the euro area’s exposure to the so-far non-stressed emerging markets was 4.7 percent. The U.S.’s was 3.3 percent and Japan’s 6.6 percent.

“It suggests that if there were to be a more serious decline in imports by China then this would carry much more significant implications for GDP in the advanced economies,” Callow said.

In a separate report, Dominic Wilson, chief market economist at Goldman Sachs Group Inc., concluded that a greater risk to rich nations may lie through financial channels. It nevertheless remains manageable, he said.

Citing data from the Bank for International Settlements, New York-based Wilson said on Jan. 29 that the developed-market banking system has $5 trillion tied to emerging markets, 20 percent of its total external position. The exposure to the economies in tumult is just $1.14 trillion, he said.

* * *

Inflation is increasingly driven by global rather than local factors, meaning central banks in industrial economies may be running overly easy monetary policy.

So say Stephen L. Jen and Fatih Yilmaz of London-based hedge fund SLJ Macro Partners LLP.

In a Jan. 22 report they outlined how forces of globalization -- such as international labor arbitrage, free trade and rise of multinational corporations -- have driven up correlations between the inflation rates of different countries, especially since the 1990s. The link is less strong for output.

The results mean that central banks targeting for inflation alone could be destabilizing because it fails to account for whether price pressures are located at home or abroad.

The Fed, for example, may have eased monetary policy too much in the mid-2000s because it under-appreciated the disinflationary effects of globalization, said Jen and Yilmaz. It may be running over-loose policies now, they said.

* * *

Immigration can have a positive effect on the average wages of lower-skilled workers, according to a new study that challenges the conventional wisdom of governments.

The paper, to be published in the Economic Journal, found that during the 1990s, immigration usually boosted the average pay of workers lacking skills in countries from the 34-member Organization for Economic Cooperation and Development.

That’s because the immigrants are typically more educated than the non-migrant natives and so create jobs, fanning hiring of those further down the job ladder, according to authors Frederic Docquier, Caglar Ozden and Giovanni Peri. They work at the National Fund for Economic Research in Brussels, the World Bank in Washington and the University of California Davis respectively.

Less educated workers enjoyed particularly large gains in countries where immigration favors educated foreigners, such as Australia and Canada, their study said. In Ireland, the U.K. and Switzerland, the wage increase was still as much as 5 percent.

* * *

Traders hit the sell button on stocks as their national teams are eliminated from the World Cup, according to researchers at the Bank of Canada -- a nation that has only been to the men’s tournament once and never scored a goal.

Ahead of this year’s World Cup in Brazil, the researchers tracked minute-by-minute trading of STMicroelectronics NV (STM) on the Milan and Paris stock exchanges during the 2010 tournament matches where Italy and France were being knocked out. Share prices that should have been equal in each city were as much as 7 basis points lower in the country whose team was being defeated, the central-bank economists said.

“A major shift in investors’ emotions, caused by a national team’s imminent elimination from a major sporting event, can almost instantaneously affect stock prices,” Ottawa-based Michael Ehrmann and David-Jan Jansen wrote in a Jan. 28 paper. The finding “contributes to the continuing debate on the efficiency of financial markets and the rationality of market participants.”

STMicroelectronics of Geneva is Europe’s largest semiconductor maker, and its shares trade at a median rate of 5,500 per minute in Milan and 4,300 in Paris. The average price difference in a trading sample taken outside a match day was 0.02 percentage points.

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net; Greg Quinn in Ottawa at gquinn1@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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