The US credit downgrade, as well as the European debt crisis, have thrown international markets into turmoil. The international financial universe is looking considerably weaker, and many are scratching their heads as they look for a solid investment in this age of uncertainty. For many, the emerging markets have held the promise of strong growth and relative stability as financial policies have vastly improved against a background of strong structural factors such as young populations and emerging middle classes. However, the emerging markets have suffered the brunt of the economic turmoil facing the Western countries, with the MSCI Emerging Market Index dropping 11% in just 5 days to 10 August 2011 following S&P’s historic downgrade of the US’s sovereign debt rating. The MSCI World Index has only contracted 8.8% this year, reflecting the situation in the emerging markets.
Probably the most alarming statistic to cite in this regard is the level of capital flight: emerging market equity funds posted the third-largest weekly outflows on record for the week ended 10 August, according to Citigroup. Funds in developing nation stocks witnessed withdrawals of $7.7 billion during the same period, taking total outflows for the year to $14 billion. This is particularly pertinent when we look at the Zimbabwean market, which is driven largely by foreign funds. The lack of liquidity forms a major hurdle for anyone looking to invest in developing markets and particularly in Zimbabwe, where the liquidity needs of individual investors have the potential to drag down prices.
The capital flight has other detrimental effects as well, as this week witnessed a dramatic drop in the value of emerging market currencies. The Dollar strengthened a worrying 3.7% against the Rand as foreign inflows dried up following a long period of relative strength. In Zimbabwe, which imports considerable quantities from South Africa, this drop in the Rand will have mixed effects but primarily it will reduce the cost of imports and neutralize the recent increase in duty on imported consumable goods. In other words, inflation may actually come out lower than forecast if the Rand remains weak.
The current turmoil in the global economy may send some investors running for the hills and seeking protection in gold and other safe havens. However, few will be looking to emerging markets and developing nations for the returns they so desperately desire, when perhaps that avenue offers them the best chance of success? Those investors who purchased shares when the MSCI Emerging Index fell sharply in 2008 were smiling all the way to the bank after a 60% rally followed over the next 12 months, and a similar trend occurred in 1998 when Russia defaulted on $40 billion worth of debt. Furthermore, emerging market earnings rose by an average 30% in the second quarter of this year, eclipsing the 5.6% rise in the MSCI World Index. Statistics released by the International Monetary Fund show that advanced nations’ economies will only grow 2.6% this year, while Zimbabwe is forecasting a 9.3% growth. Inflationary pressures are also likely to dissipate as the crisis has hit the commodity markets. A number of analysts have suggested that the knee-jerk reaction to the credit downgrade in the US has gone too far, and that emerging market stocks are looking attractive. Zimbabwe carries the added bonus of being in a recovery phase, isolated from currency risk due to the use of the US Dollar, and offering attractive earnings.