India leads emerging-market charge at G20

Hot money is suddenly giving emerging markets the cold shoulder, setting up a confrontation within the Group of 20 as India, South Africa and others blame the United States for weakness in their currencies.

Market turbulence caused by an expected monetary policy shift in Washington will feature prominently in discussions slated among G20 leaders during their summit in St. Petersburg over the next two days, possibly exacerbating tensions about a response to unrest in Syria. India has already made clear that it will be urging G20 leaders to at least recognize the global side effects of monetary policies adopted by large countries such as the United States.

Indian Prime Minister Manmohan Singh underlined his country's concerns in a statement as he left for the summit, saying he would emphasize to the other leaders "the need for an orderly exit from the unconventional monetary policies being pursued by the developed world."

That is crucial, he said, to make sure growth prospects of the developing world are not damaged.

The economic discussion at this G20 meeting represents a reversal of the 2011 summit in France. Then, the U.S. Federal Reserve's bond-buying program, known as quantitative easing (or QE), was in full swing. The Fed has bought about $85-billion (U.S.) worth of bonds a month to keep credit flows strong enough to spark an investment-led recovery in that country.

The cheap credit environment created by the program also drove investment cash into emerging markets as investors sought higher interest rates.

This influx of capital, dubbed "hot money," caused currency values in emerging markets such as Brazil to spike. Now, with Washington planning to scale down QE and eventually retire the program, emerging markets are watching investors pull their money back to the United States.

"Clearly the prospects of higher interest rates in the U.S. are reversing this hot money issue and all of a sudden the discussion will be toward 'How can we keep some of this hot money in those economies?'" said Benjamin Tal, deputy chief economist of CIBC World Markets.

The geopolitical clout of India, Brazil, China and other developing countries has risen in tandem with their economic growth, which prompted the establishment of the G20, a grouping that has overshadowed the Group of Seven in recent years. That evolution has forced members of the smaller forum, including Canada and the United States, to take emerging markets more into consideration when formulating economic policies.

Still, some analysts see factors other than U.S. monetary policy – some of them self-inflicted – as causes for currency weakness in India and other developing members of the G20.

Tuuli McCully, Bank of Nova Scotia's senior international economist for Asia, points to India's political instability, high inflation and poor public finances as areas that are of concern to investors.

"India has fundamental issues why markets are now differentiating it from other emerging Asian markets," she said. "It's not fair to only point at the tapering by the U.S. [as] being the reason for the capital outflows."

"The market has been particularly brutal to countries that need to finance significant ongoing current-account deficits, such as Brazil, India, South Africa, and Indonesia," Harvard University economics professor Kenneth Rogoff said in a recent commentary. "Years of political paralysis and postponed structural reforms have created vulnerabilities."

The "ultra-easy monetary policies" in advanced countries helped generate growth in the developing world, but they also obscured weaknesses, Prof. Rogoff said.

Martin Schwerdtfeger, senior international economist at Toronto-Dominion Bank, said the expectation of QE tapering by the U.S. Fed has "cast a light" onto those structural weaknesses.

If concern about stimulus tapering were the only element driving volatility and weakness in emerging markets, there would be a broad-based sell off in all those countries, but that is not the case, he said. The countries that are suffering the most are those which also have severe internal problems.

India's economy is in particularly bad shape, because of corruption, a large budget deficit and a widening current account deficit. In addition, its gross domestic product growth fell to about 3 per cent in 2012, well below 6 per cent in 2011 and a double-digit clip in 2011, according to World Bank data.

Surendra Kaushik, a finance professor at Pace University in New York, said the Indian government has yet to lay out a coherent plan for tacking the deficits or overall lagging economic growth.

Prof. Kaushik said that right now, the Indian government is making things worse. This week it passed a $20-billion food security bill, which would subsidize wheat, rice and other cereals for up to 800 million people.

"The government is handing out goodies they don't have," Prof. Kaushik said. "Each ministry more or less initiates its own programs. The finance ministry and the planning commission put them in the budget, and then they go to international markets to borrow the needed funds."

TD's Mr. Schwerdtfeger said comments such as those of Prime Minister Singh are usually made for domestic consumption, rather than with the intent to sway policy in other countries. "It is very unlikely that the Fed will take those [comments] into consideration when they decide to set their monetary policies," he said. "But from a political point of view it is important for [Mr. Singh] to bring that issue up, and it is done to target [his] domestic audience.