Emerging markets suffer as foreigners withdraw

The global financial crisis has cost Grace Varghese, 50, a day trader in India's high-tech hub of Bangalore, more than $50,000.

"I take high blood pressure tablets now," said Varghese, who started trading stocks four years ago after her children moved out. "I was crying to my husband and children: I lost! I lost! I lost!"

That pain, she believes, has little to do with India itself and a lot to do with foreigners.

"Indian fundamentals are strong," she said. "I don't believe in Dow Jones."

Most emerging market stocks have fallen harder in Asia, Russia and Latin America in recent weeks than they have in the U.S. and Western Europe.

A big reason for that, analysts say, is because foreign investors - who over the last four years fueled the emerging markets boom - have lost their appetite for risk amid the credit crunch and are yanking money out to meet redemptions at home.

In particular, the pullout by highly leveraged hedge funds which had to repay debts, triggered the decline, which in turn spooked other investors, economists say.

The potential for handsome returns - or devastating losses - are why emerging markets are considered so risky.

"It cuts both ways. You can't say I'd like the upside but I want someone to protect me from the downside," said Subir Gokarn, chief Asia-Pacific economist for Standard & Poor's in New Delhi. "When you decide to liquidate a portfolio, you look first at accounts that have given you the maximum return."

The exodus has prompted a chorus of protest in the emerging world: We did not cause this global meltdown, our economies are still growing, our banks don't have much exposure to the toxic securities at the core of this crisis.

Why must we suffer, they ask.

"It doesn't seem fair to me that those of us who endured so much hunger in the 20th century, who began to improve in the 21st century, should have to suffer due to the international financial system," Brazilian President Luiz Inacio Lula da Silva said recently.

India's Finance Minister P. Chidambaram this week again said that India's economic fundamentals are healthy. "We must banish fear," he said.

While emerging markets have rebounded some this week, they still remain down sharply this year - and the outlook remains murky.

The global financial crisis threatens to tip the U.S. and Europe into recessions, weakening demand for exports, both commodities and finished products, from developing nations. Also, declining emerging market stocks will likely weaken consumer spending in markets like India and China. It also means less capital is available to fuel growth.

Moreover, the drop in commodities prices has hurt countries like Brazil, home to Petrobras, one of the world's biggest publicly traded oil companies, and Vale do Rio Doce, the world's number-one producer of iron ore.

Local markets "keep getting dragged into the bottomless negative frenzy from the U.S.," said Enrique Alvarez, head of research for Latin American financial markets at IDEAGlobal in New York.

In India, where foreign institutional investors have pulled out $10.6 billion this year, the benchmark Sensex index has lost nearly half its value.

Indonesian markets are down about 40 percent this year, with JP Morgan, Merrill Lynch, and Credit Suisse leading the sell off in recent weeks, according to Irvin Patmadiwiria, the head of investments at PT Lautan Dana Investment Management.

South Korea, where net selling by foreigners so far this year has totaled 29.9 trillion won ($24.8 billion), has seen its benchmark stock index shed more than a quarter of its value.

Sao Paulo's Ibovespa index tumbled 31 percent in 11 trading days to its lowest level in two years before rebounding some.

Russia's stock market, battered by foreign outflows, plunging commodities and the August war with Georgia, is among the world's worst-performing, down more than 60 percent from record highs in May.

Analysts estimate foreign capital accounted for at least half of trading on the Russian stock exchanges before August.

The Central Bank estimated that $17 billion of net private capital investment was withdrawn from Russia in the July-September quarter. Independent estimates put the figure even higher.

The rapid outflow of foreign money has caused several currencies across Asia and Latin America to plunge, pushing even more foreign investors to flee as they try to stem currency losses.

Depreciation has raised import costs, threatening to accelerate inflation and straining current account deficits. Some governments- like Mexico, which sold a record $6.4 billion in reserves last Friday to proposition up the peso - have had to tap foreign exchange reserves to salvage local currencies.

The Institute of International Finance, a consortium of global financial services firms based in Washington D.C., estimates that private sector capital flows to 30 emerging market nations across the world will fall by nearly a third from last year to $619 billion this year. Next year, they predict the sum will fall by another $60 billion.

Emerging markets are also suffering from a credit squeeze. Interbank lending has plunged and corporate bond issuance has stalled, according to the IIF.

On the positive side, foreign direct investment in emerging markets has remained relatively robust, experts say.

So far the flight of foreign money hasn't threatened to spark a repeat of the 1997-1998 Asian financial crisis, when countries ran out of funds to pay foreign-denominated debt, economists say.

"Overall reserve positions look healthy," said Gokarn.

Amitabh Chakraborty, president of equities at Mumbai's Religare Securities Ltd., says South Korea and Indonesia, where foreign-held short-term debt and equities are more than double foreign exchange reserves, are most vulnerable to outflows.

Carol Wise, an associate professor of international relations and the University of Southern California, says emerging markets will continue to suffer until the U.S. gets its act together.

"Emerging markets are taking the bigger hit because they're more vulnerable," she said, adding that countries like Brazil, Mexico, Chile, and Peru, which have been disciplined about financial sector reform and have adequate foreign currency reserves, will likely recover fastest.

Rajesh Jain, CEO of Pranav Securities, a Mumbai brokerage, sees current valuations as "the beginning of a buying opportunity." But, he cautioned, "Until you have 15 to 20 days with no bad news, you can't say we've turned a corner yet."

Chakraborty said he doubts the boom years will be back anytime soon.

We are, he said, entering an era of slower growth, which will be reflected in lower stock market valuations.

"The fundamentals have changed," he said.

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Associated Press writers Bradley Brooks in Rio de Janeiro, Kelly Olsen from Seoul, Theresa Bradley in Mexico City, Anthony Deutsch in Jakarta and Nataliya Vasilyeva in Moscow contributed to this report.