“God, glory and gold!” In the 15th century, this denoted the Europeans’ primary motivation for venturing across the seas the same motivation that ushered in the Age of Exploration. The search for a direct northwest passage to the Orient the home of silk, spices and untold wealth – unwittingly led to the discovery of hitherto unknown (but equally alluring) civilizations in Africa and the Americas. Not surprisingly, in their quest, the medieval explorers not only laid the foundation for imperialism and colonization but also reinforced the belief that opportunities abound across the globe.
The modern-day investor may not carry the ruthless aura of Vasco da Gama or Christopher Columbus, but his quest for high yield coupled with his arbitrage-seeking tendency still makes him disregard national boundaries and look at the entire world as his hunting ground.
In the wake of the 2007-08 financial crisis, when the US Federal Reserve and central banks of other developed countries went on a quantitative easing spree, leading to unprecedented drops in interest rates, yield-starved investors fled from the developed world into the emerging markets in search for higher returns.
In case of the emerging markets, cross-border capital inflows, an offshoot of the opportunistic investors’ sudden fascination with these markets, have continued to dwarf trade flows for most of the last decade, leading to increasing US dollar values of their currencies. At the same time, the nominal GDP of a number of emerging countries shot up creating an illusion of growth that was more attributable to the rapid appreciation of their currencies than to an equally impressive rise in real output (or inflation-adjusted GDP).
To put this in perspective, between 2003 and 2011, just about one-tenth of the nominal GDP growth experienced by Brazil the poster child of the then awe-inspiring BRICS economies could be attributed to rise in real output; the rest of the growth came from the around twofold surge in the value of the Brazilian real.
The problem was that the stellar nominal GDP growth had masked many of the structural problems inherent with the emerging market growth story. For instance, buoyed by investors’ newfound confidence, a number of emerging economies from India through Brazil to Indonesia ran huge current account deficits, oblivious to the vulnerability posed by sudden capital outflows.
At the same time, the emerging markets tended to ignore the dangers of high inflation at their peril. The Achilles’ heel of the emerging markets’ growth came to the surface in May when, following the Fed’s announcement that it might “taper” its QE program, investors retreated their funds from emerging markets back to the United States.
To many, the huge slides in currencies that ensued were just a testament of the emerging market bubble that was bound to pop at some point.
Whether or not this is just a temporary submergence of the emerging markets, remains a topic of hot debate, but one thing is certain: investors’ over-the-top fascination with any market is detrimental because it remains fairly transient.
India will vouch for this. Had there not been the complacency brought forth by the bandwagon effect for BRICS economies, India would have spared more attention towards taking care of the structural problems in its economy.
Now with the interest rate differential between emerging markets and developed ones becoming minuscule, a lot of the “hot” money of overseas investors may find their way to the frontier (or “pre-emerging”) markets in another quest of high yields. These frontier markets around 30 less developed countries, including Bangladesh indeed carry higher risks than emerging ones, be it in the form of lower liquidity or more rampant corruption. However, the mere fact that these markets offer the potential of higher growth (much to the envy of the once booming emerging markets) may eclipse their risks for many investors.
In case the investors indeed start taking interest, Bangladesh just like other frontier markets must be wary of not following the path taken by emerging markets. Nominal growth should never be a substitute for real growth when assessing an economy’s health; neither should a current boost in capital inflows be regarded as a harbinger of continued investor confidence in the economy.
The medieval European explorers might have been too reluctant to leave the colonies that they founded, but today’s investors hardly want to remain part of their once favorite market in face of adversity. After all, unless an emerging or frontier market’s growth story has its roots in real output rise, it is not really growth, but another bubble. And the fleeting investors very well know this!