In a fierce sell-off, currencies of emerging markets plunged on Tuesday. Year-to-date, the South African rand is down 16.88 per cent. The other worst hit currencies are - Brazilian real (down 15.2 per cent), Indian rupee (down 14.8 per cent).
Indian rupee is the worst performer in the Asian pack, crossing the 64 to the dollar mark yesterday- a record low.
Market observers feel that this bout of weakness is triggered by the fear that the Federal Reserve may soon start unwinding its $85-billion bond purchases. This will suck the liquidity that has so far supported asset prices in emerging markets. The money which came into the emerging markets in the last five years as the US set its stimulus plan rolling, is flying back now and investors are fast winding up their positions.
The US benchmark 10-year treasury yield hit 2.9 per cent on Monday - a two-year high - as bond prices in the US fell on expectations that the demand for these instruments will fall as the Federal Reserve tapers its bond re-purchase program.
Bond yields spike
According to EPFR Global, a global fund flow tracking company, outflows from emerging market debt funds continued in August with $184.6 million moving out of these funds in the first week.
In India, foreign institutional investors have pulled out Rs 6,058 crore from the debt market so far in August. Their pullout year-to-date totals to Rs 27,183 crore – this is close to 18 per cent of their total investments in the country’s debt market since 1992.
On Tuesday, the yield on the 10-year India government bond hit 9.47 per cent, the highest in the last five years. Government bond yields in South Africa and Indonesia have also risen quite sharply on sell-off by investors.
At 8.3 per cent, South African yields on Tuesday closed at a 52-week high. The yield of the 10-year Indonesia government bond is at 8.2 per cent, up 238 basis points in the last one year. The yield was at similar levels last in March 2011.
Foreign investors pulling out of the debt market in the emerging markets is causing a decline in bond prices, leading to the yields spiking (as bond prices and yields move in opposite directions). The pull-out of debt is causing the currency to weaken, which is leading to more bond sales by overseas investors -- a vicious cycle.
However, most emerging markets have fundamental troubles too, with a widening current-account deficit and slowing economic growth. Indonesia, for instance, saw its current account deficit jump to 4.4 per cent of GDP in the June quarter, up from 2.5 per cent recorded in the January-March period. Also, the country’s GDP growth fell to 5.8 per cent in the April-June quarter from 6.2 per cent recorded in the previous quarter.
In South Africa and Brazil again, there are worries over slowing economic growth with steadily increasing inflation and a ballooning fiscal deficit.