Slower growth and financial stability risks, which could come to light in a less upbeat global economic scenario, will put the newly-acquired resilience in emerging markets to the test, and credit booms in some of the emerging economies should not be neglected, Andreas Dombret, member of the Bundesbank’s executive board, has warned.
In a commentary written for Emerging Markets, Dombret, who was the vice-chairman of Bank of America Global Investment Banking in Europe, the Middle East and Africa, noted that some emerging markets “have begun to acquire a relative safe-haven status” during the eurozone debt crisis.
The fact that the outflows from emerging markets during “risk-off” periods were short-lived “also suggests that inflows are not only driven by the search for yield but also by structural shifts,” Dombret said.
“Higher allocations to emerging market assets could, therefore, well be a long-term structural phenomenon,” he wrote.
But the progress in attracting international investors to local bond markets in emerging countries could easily be reversed if economic conditions become worse than anticipated, Dombret warned.
“In several emerging markets, foreign holdings of local debt have reached historical highs. While the development of local bond markets has been a goal pursued by many emerging markets, this introduces new vulnerabilities into the financial systems in the event of a sudden stop or even a sudden reversal of capital flows,” he wrote.
Underlying financial stability risks are looming beneath the surface of increased stability and prosperity in certain financial systems and market segments, he said.
“An extended phase of high credit growth and sustained asset price increases, especially in the real estate sector, has been the downside of the boom in many emerging markets.”
Over the past five years, double-digit growth in private sector credit, which fuelled consumption, has been common in several major emerging economies, he noted.
When the ratio of debt to disposable income is considered, “consumer balance sheets in selected emerging markets appear to become a bit strained,” Dombret said.
“Moreover, credit demand has also been fuelled by rising property prices. Sustained property price increases may hint at the risk of asset bubbles building up in some markets. However, backlog demand, short data series and data gaps make it difficult to draw final conclusions here.”
He noted the slowdown in the BRIC countries – Brazil, Russia, India and China – saying that emerging markets, too, were about to enter a more challenging phase, as the combination of historically low interest rates and weak economic growth in developed countries was “not going to disappear any time soon.”
“Although credit quality generally appears good, it has already begun to deteriorate in some countries. After all, credit quality is often overestimated in boom times,” Dombret warned.