Emerging markets are not homogeneous

Emerging markets are located from the western reaches of the Americas to the far east of Asia, but recent weeks have shown that the countries in this asset class are far from homogeneous.

A three-pronged assault from QE tapering fears, concerns about Chinese growth and now the prospect of military intervention in Syria has led to spreads widening sharply in many emerging market sovereigns.

Brazil, Turkey, Indonesia and India have all seen their currencies and credit standings come under attack. The first three countries' spreads have more than doubled since early May, and India's CDS (365bps) are trading at their widest level for over a year.

Korea's spreads, on the other hand, have only widened 14bps to 85bps over the same period. Granted, it has a superior credit rating to the aforementioned sovereigns, so one would expect it to trade tighter. But its outperformance might be surprising to those who remember its suffering in the currency crisis of the 1990s.

Things, however, have changed since 1997. Korea's local currency ratings are only one notch higher now at Aa3/A+, so there must be other reasons for its relatively strong performance. The most likely explanation is to be found in its trade position. Korea has a current account surplus of about 4%, and it has maintained a positive number for several years.

This gives the country flexibility and places it on a robust footing, unlike Brazil, Turkey, Indonesia and India, all of which have considerable current account deficits.

These countries have been forced to defend their currencies using a variety of measures, including interest rate hikes, currency swap arrangements, import tariffs and direct intervention in the foreign exchange markets. They have had limited success so far, and it remains to be seen whether the markets will be placated.

However, it should be stressed that emerging markets as a whole are stronger than where they were in the 1990s. Foreign exchange reserves as a percentage of short-term liabilities are far higher, and the proportion of debt denominated in external currencies is significantly lower.

Private debt, however, is uncomfortably high, and this is probably the main vulnerability of many countries in the asset class. Higher interest rates in a post-QE era will test just how far emerging markets have come since the last crisis.

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