Some emerging markets show signs of overheating
Fast growth and better fundamentals make emerging markets attractive investment destinations, but some may be overheating, analysts say
Analysts at Deutsche Bank looked at 3 factors that give early warnings on whether economies are overheating for a set of 36 emerging markets, and noticed that two-thirds of the countries have shown signs of excess growth to varying degrees in at least one of the indicators during the past 3 years.
The 3 factors that analysts Maria Laura Lanzeni and Christian Weistroffer looked at in their research were credit-to-gross domestic product ratios, equity prices deflated by consumer price inflation and the real effective exchange rate (REER).
Their analysis compared the actual performance with the trend and does not necessarily mean that if an indicator shows rapid growth it is a negative sign, as, for instance, a country could experience financial deepening starting from a low credit-to-GDP level.
Five countries China, Malaysia, the Philippines, Thailand and Peru showed alert levels for 2 indicators, warranting a more in-depth look at possible overheating risks in these countries, according to the Deutsche Bank analysts report.
For China, the strongest and most persistent signal is for the REER it has flagged since early 2008, the report said.
Whatever ones opinion about the fair value of the renminbi, our findings show a fairly strong real appreciation in recent years, the analysts added.
The second indicator that could constitute an alert signal for China is credit growth, but this is concentrated at the beginning of the 3-year period, with recent developments showing more moderate credit-to-GDP growth.
BRAZIL, PERU CURRENCIES
For Malaysia, the signs to watch are the sizeable REER appreciation a cumulative 16% since 2010 and significant credit growth in excess of GDP growth, a 12 percentage points increase since 2010.
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Thailand has the strongest signals of overheating, with the current stock market gap versus the long-term trend at 66% and the REER almost 10% above trend, while credit-to-GDP is around 8% above trend.
In Peru, the signs of overheating were shown in the REER gap and credit gap.
Elsewhere in Latin America, an overvaluation signal for Brazils exchange rate lasted until early last year and weakened after that.
There were no signals of overheating in Central and Easter European credit, which is not surprising given that many countries in the region already experienced a boom-and-bust cycle in recent years, the Deutsche Bank analysts said.
In the Middle East and Africa, there are strong and persistent signs of overvaluation for Nigeria, with a 30% REER gap with respect to the long-term trend and a 21% gap for equities.
Credit growth, on the other hand, remains subdued, possibly related to Nigerias past banking problems. This may mitigate overheating pressures emanating from the other 2 indicators, at least for now, the analysts said.They stressed that the threat of full-blown crises in emerging markets which are in much better economic shape as they had improved their economic policies and reduced external and internal imbalances - has receded markedly but a hard landing after overheating could still be damaging.
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