There's a lot of concern about emerging markets right now: Investments tied to these markets have been sinking fast, and the bigger concern is what's coming.
With the Federal Reserve expected to continue tapering its monthly bond purchases when it releases its monetary policy decision this week, it doesn't take a particularly wild imagination to see things getting worse – marked by further currency declines and investment withdrawals, amid a backdrop of political turbulence.
Julian Jessop, chief global economist at Capital Economics, is trying to put things into perspective though, and he provides a surprisingly upbeat outlook.
"Although some currencies have fallen sharply this month, it still does not seem right to talk about a new financial crisis sweeping across all emerging markets," he said in a note. "What's more, the economic slowdown in China, which is also unsettling many investors, may well prove to be benign. The global fall-out from the present uncertainty should therefore be limited too."
While some commentary has been comparing the current situation to the 1997 crisis in emerging markets, when trouble began in Thailand before spreading to South Korea and Russia, Mr. Jessop prefers to compare the situation to last summer. That's when the Fed first began to contemplate an end to its bond-buying stimulus, known as quantitative easing or QE, rattling emerging markets as investors fled.
But while emerging market assets saw big net outflows in December, they weren't as bad as last June. "Timelier data from stock exchanges also show that net foreign sales of Asian equities remain well below the peak they reached seven months ago," he said.
He argues that there are two essential points for understanding the broader implications of the current turmoil, and neither supports a panicked response.
1. Emerging markets are now a diverse group of countries, which means they will respond differently. For example the Argentine peso has been sideswiped because of years of economic mismanagement, while the Turkish lira is getting hit because it is difficult to finance a current account deficit when global monetary conditions are tightening.
2. The economic slowdown in China is a step toward rebalancing its economy: "The recent weakness in manufacturing partly reflects a policy decision to dampen excessive credit which the authorities could reassess if growth threatened to collapse. The reforms agreed at the Third Plenum last year should also allow China to sustain stronger growth over the medium term than it would otherwise have done."