Sell-Offs Hurting Emerging Markets

Investors Leave Nations in Lurch

SHANGHAI -- Investors who helped build the financial boomtowns of developing countries in recent years are now fleeing them, threatening to destabilize burgeoning economies and drag the world into a deep recession.

More than $1.3 trillion in value has been wiped off emerging market stocks this year in cities such as Moscow, Sao Paulo, Jakarta, and Osaka. There have been violent sell-offs of local currencies, a plunge in private equity investment, and a falloff in mergers and acquisitions.

"There has been tremendous redistribution with the credit crunch. People are selling their higher risk assets -- and emerging market equities qualify as higher risk," said Alec Young, international equity strategist for S&P Equity Research in New York.

The massive and sudden withdrawal of money is leaving behind half-finished infrastructure projects, driving vast swaths of companies out of business, and pushing local currencies to new lows, analysts say.

In Mexico, the central bank has auctioned off $11 billion in foreign currency reserves since last week in an attempt to defend the peso, which recently hit an all-time low against the dollar. In Russia, finance officials unveiled a plan to buy up to $20 billion of shares to bolster a stock market that has plunged more than 73 percent from its peak. And in Pakistan, the government is seeking billions in emergency aid to avoid going bankrupt.

Economists fear that emerging markets will prove to be the weak link in the global economy and that the collapse of one or more of them could create dangerous consequences for the rest of the world.

"So far, the U.S. financial sector has been the epicenter of the global crisis. I fear that a hard landing in emerging markets assets and economies will become the second epicenter in the coming months," Stephen Jen, a managing director at Morgan Stanley, wrote in a report this week.

The International Monetary Fund has forecast that worldwide growth will slow significantly, from 5 percent in 2007 to 3.9 percent this year and to 3 percent in 2009. World Bank President Robert Zoellick has said that developing countries -- which are already suffering from the twin shocks of food shortages and high oil prices -- are at a "tipping point."

"A drop in exports will trigger a falloff in investments. Deteriorating financial conditions combined with monetary tightening will trigger business failures and possibly banking emergencies. Some countries will slip toward balance-of-payments crises," Zoellick said in a speech last week.

The problems of emerging markets are also American problems. Many U.S. mutual funds and pension funds now hold large stakes in emerging markets -- as much as 8 to 10 percent for some pension funds. Already this year the average emerging market stock fund is down nearly 53 percent, among the biggest losses of the fund categories tracked by Morningstar.

At Wall Street firms such as Merrill Lynch and Goldman Sachs, emerging markets had been among the most popular specialties; the banks underwrote billions of stocks and bonds in Latin America, Asia and Eastern Europe. Private equity and venture capital firms rushed to set up satellite offices in remote parts of the world.

As recently as the summer of 2007, California's Calpers, the nation's largest pension fund, was so optimistic about the future of emerging markets that it expanded its holdings, committing $500 million to two different emerging markets investment funds and more than $5 billion to stock holdings. Pension funds for Montgomery County, the District and practically every other public entity also dove into emerging markets investments.