Capital flight and emerging markets By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

September 15, 2015 | Posted by bobbysrinivasan << back to blog

When it comes to the inflow of money in to an emerging market economy, it is always at the beck and call of developed economies. When the money flows out these emerging economies, it affects their economic performance comprehensively. The stock and bond market where their short term funds are parked go in to a tail spin when the money flows out. In 2008 during the sub-prime crisis nearly $50 billion left our shores and this pushed our stock market index (Sensex) from 21,000 to 8,000. As the funds leave the overall confidence in the economy takes a beating. Traders and rich people move their funds out of the country fearing a capital control. This is basically a financial slavery and the value of the domestic currency drops to ridiculous level. Recently Brazilian Real has seen a 35% drop in currency value. The Russian Rouble has dropped from 32 to a dollar to 65 to a dollar, literally destroying its value.

Now let us look at what is happening today. The flood of capital gushing out of the emerging markets has risen towards $ 1 trillion in the last 13 months which is roughly double the amount that left during the financial crisis of 2008. The sustained exodus is certain to slow the economic growth and weakening currencies. The much bragged about the spectacular performance of emerging economies has vanished into thin air and those countries are just in a quandary wondering where to find the finance to achieve their targeted future economic growth. To add fuel to the fire China has taken the route of currency devaluation to maintain its market share of exports. Also when the US Fed Chairperson decides to jack up the fed funds rate from its current level the outflow of funds from these economies will pick up momentum. What can be done about it? For the traders it is simple, just buy the US dollar by selling these emerging economy currencies.

The outflows mark a sharp reversal from the robust infusion of funds that emerging markets received in the six years following the sub-prime crisis as they helped invigorate the feeble global economy. From July 2009 to till the end of June 2014 nearly 2 trillion US dollars flowed in to the 19 emerging markets. As the funds move out, it will drive down the aggregate demand in those countries both from domestic as well as from imports. According to Neil Sheaving of Capital economics and I quote, “The collapse in emerging market imports reflects a more fundamental drop in demand as capital outflows have forced domestic demand to shrink and lower commodity prices have eroded incomes in commodity producing countries. So far there is little sign that we have reached the bottom. Added to all this misery political tensions in Turkey, Russia, Brazil and Malaysia are undermining the general global confidence.

Finally we in India are somewhat indifferent to these crises. It is unlikely that we are prepared to meet these eventualities. Currently the Indian stock market is bleeding and the retail investor’s small capital is being wiped out. Inaction and empty promises will not save us. We need proactive action. Will it ever happen?

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