Investors are still scratching their heads over Indonesia's surprise rate cut on Tuesday, when the central bank lowered the reference rate 25 basis points to 7.5 percent. They're more likely to find an explanation in Frankfurt, Tokyo and Washington than in Jakarta.
At 6.96 percent, inflation is outpacing 5 percent growth in Indonesia. Maybe Bank Indonesia Governor Agus Martowardojo is worried about mounting deflation pressures around the globe. More likely, he's recognizing another dynamic at work: The boost that quantitative easing in advanced economies has delivered to emerging markets such as Indonesia may be coming to an end.
I'm not referring here to the possibility of an eventual Federal Reserve interest-rate hike, or even the Bank of Japan's failure to expand its monetary base today. There's growing evidence that emerging markets are simply benefiting less and less from existing QE programs. What's more, the U.S. is starting to attract much of the liquidity that those smaller countries have grown dependent upon. "For 2015, the story may be of surprisingly strong asset performance in the U.S. combined with a continued poor performance in the emerging world," says Adam Slater of Oxford Economics in London.
The conventional wisdom still holds that developing-nation assets will gain from any additional stimulus from the euro zone and Japan. In a new report, however, Slater warns that the shrinking of the differential in gross domestic product between advanced and developing economies -- it's now the smallest since 1999 -- might well drive liquidity out of Asia. The growth gap in 2015 may be 1.2 percentage points, compared with about 4.5 percentage points between 2000 and 2014. In fact, excluding China, emerging-economy growth could be just 2.8 percent this year, not that much more than that of the Group of Seven nations.
Yield spreads also make riskier economies less appealing. While 10-year yields in, say, Indonesia are higher than in the U.S. (7.07 percent versus 2.12 percent), real interest rates are becoming a turnoff. They're also either negligible or negative in Argentina, Mexico, South Africa, South Korea, Thailand and Turkey. Oxford's sample of 13 key emerging economies shows that real rates averaged 1 percent in 2014, compared with roughly 3 percent since 2000. Not surprisingly, portfolio investment flows have decreased. On a six-month average basis, flows into emerging markets were just $11.6 billion in January, roughly equivalent to lows seen in 2013 when talk of crisis was in the air from Jakarta to New Delhi.
The last two rounds of major QE injections -- by the European Central Bank last month and the BOJ in October -- resulted in only minor boosts to emerging markets relative to previous ones. Part of the problem is diminishing returns; too much liquidity chasing too few good investments. It also may be that, as the issuer of the reserve currency, the U.S. has longer monetary coattails than Japan or Europe. Or are emerging markets losing their appeal?
The answer to this question should worry officials in Asia and elsewhere. In a sense, the QE-fueled boom of recent years made things too easy for them. "It has funded abnormal growth globally, compared to the cycles of the previous century," says Marshall Mays, director of Emerging Alpha Advisors in Hong Kong.
The U.S. resurgence has its benefits, of course. As America's 2.5 percent growth rate accelerates, U.S. households will buy more Asian goods. But in the short run, Asia may run short on economic fuel. All that hot money, as I've written before, deadened the urgency for governments to upgrade their economies. As data series across industries soared, leaders focused more on ribbon-cutting ceremonies for new skyscrapers and factories, rubber-stamping foreign direct-investment deals and basking in headlines about rising share prices than in stabilizing economies and strengthening financial systems.
Now, as capital flows recede and China slows, governments face pressure to loosen fiscal policies, redouble efforts to create jobs and bolster their appeal as investment destinations. This is hard work they should have done when times were good. They'd be smart not to wait any longer than they already have.
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