Bubbly emerging market risks high

By Neil Behrmann

December 06:- The European Central Bank warns that global pension funds and insurance companies should now stop pouring money into Asia and emerging markets.

Foreign money in particular has been flooding into Asia and China and other Asian markets, which have soared since their setback in May and June. Such have been the flows that Emerging Portfolio Fund Research (EPFR) estimates that Asia excluding Japanese funds have attracted a record $14.3 billion, dominating flows into emerging markets equity funds. This compares with $8.4 billion in the whole 2005.
Pension funds and insurance companies in the US and Europe have been major investors in emerging market funds. In recent weeks there was profit taking in Eastern European markets, but money has continued to pour into Asia, according to Brad Durham, managing director of EPFR. The bulk of the portfolio flows have gravitated towards China, he says.

Soaring Asian and other emerging markets

These flows have helped boost equity prices in the region. From their low point in the second quarter 2006 to their highs in recent days, the stock market indices of China have surged by 59 per cent, India by 56 per cent Indonesia by 52 per cent, Hong Kong, by 28 per cent, Singapore by 27 per cent, Malaysia by 24 per cent and Korea and Taiwan by 23 per cent. The appreciation from the 2003 lows have been substantial with Singapore, for example, up by around 130 per cent and the Indian market by almost 400 per cent.
The current popularity of Asian and emerging markets contrasts with the steep declines and considerable foreign outflows in May and June. Those investors who disagreed with the pessimists made fortunes in a short space of time.

Shrinking foreign inflows would cause a market slide

The recovery of emerging markets from that setback “may be seen as a testament to their increased resilience to crises”, the ECB says in its latest Financial Stability Report. But it warns that the markets are still to be tested if the US economy experiences a steep slow down and the global profit cycle dips downwards.

If funds and other investors decided to take profits there could be another down cycle similar to May and June. Under such circumstances, global banks and their counterparties – especially institutional investors and hedge funds – could face increased risks from falling asset prices, comments the ECB. The Institute For International Finance, the global association of financial institutions with over 360 member institutions, forecast in a recent report that total net private capital flows into emerging markets would fall to US$404 billion in 2007 from US$418 billion this year and a record of US$480 billion in 2005. The expected decrease in flows partly reflects a forecast slowdown in global growth and overall investment activity.

Asian markets helped by cheap currencies

On the other hand the depreciation of Asian currencies against their European counterparts make Asian markets relatively cheap for European investors, fund managers say. It also boosts Asian exporters. Standard and Chartered Bank disagrees with the gloomy fears of the ECB.

“Some doomsayers predict 2007 could be a year of financial turmoil, as suggested by the "curse of 7", which is evident from the 1987 stock market crash and the 1997 Asian Financial Crisis,” the Bank says in a report. “We agree that growth in Asia will moderate in 2007, and it will be a year that needs more vigilance and less complacency, but we do not see the justification for crisis.”

“Despite a slowing US economy and austerity measures, China's economy will continue to defy gravity in 2007. Inflation may rise, as might interest rates, the renminbi and China's external surplus, but all in steady and modest magnitudes.”


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