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The Future for Emerging Markets

BERKELEY – Over the past year, the global economic environment changed markedly and in unexpected ways. Energy and commodity prices plunged. Growth in China (which accounts for about 40% of global growth) fell to its lowest rate since 1996, even as its stock market soared to unsustainable heights. The United States and the European Union ratcheted up economic sanctions on Russia in response to its military excursions in Ukraine, highlighting the geopolitical risks associated with cross-border investments. And there have been large swings in exchange rates, fueled by actual or, in the case of the Federal Reserve, anticipated changes in monetary policy.

These rapid changes have rattled global financial markets and spooked investors, reducing their appetite for risk – a cautious attitude that has been reflected in emerging markets. Investors have sat on the sidelines, and the MSCI index that tracks returns on emerging-market equities has stagnated.

During the second half of last year, the 15 largest emerging-market economies experienced the biggest capital outflows since the 2008 global financial crisis. And the aggregate foreign-exchange reserves held by emerging countries declined for the first time since 1994, when they began the steep upward climb that has been a defining feature of the global economy during the last two decades.

One major factor driving the lackluster performance of investments in emerging markets is the expectation that the Fed will begin to raise interest rates and normalize monetary policy later this year. In a recent speech, Fed Chair Janet Yellen confirmed that such steps would be “appropriate” if the economy continues to improve, stating that “delaying action to tighten monetary policy until employment and inflation are already back to our objectives would risk overheating the economy.”