Shock Politico-economic Insecurity in Chile Discomfits Emerging Markets Investors

RIO DE JANEIRO, BRAZIL – Chile’s crisis is reflecting general uncertainty among international investors in emerging markets, where yields have been sluggish for years.

Despite interventions by central banks, the pressure is likely to persist. With the collapse of the Chilean peso, tension on Wall Street has soared. The crisis began with citizen protests, which have now apparently prompted a referendum on the Chilean economic model.

And this is happening in Chile, of all places, where the Wall Street wise men have been praising the success of the liberal Western economic system for decades. But that has now come to an end. Since late September, the peso has suffered heavy losses, which has also had a very negative impact on the Santiago stock exchange.

Although Chile is a small country, the crisis is worrying Wall Street traders. Among other things, it illustrates the disappointing performance in Latin America in recent years.

Nothing has come of the many promises of reform and growth. Quite the opposite: while investors have long since turned their backs on the region, citizens are now taking to the streets.

A lost decade

However, Latin America is not alone in this. Performance in other emerging markets over the past ten years has also been extremely disappointing. Memories of the 1980s awaken, when Latin America in particular had to mourn a lost decade.

The results are particularly depressing given that the 2008 financial crisis presented an opportunity for the emerging markets. At that time it was said that Americans were on their (economic) knees and could only save themselves from collapse by the USA printing more mone–which it did.

As a result, the currencies of emerging markets rose sharply. The Chilean peso alone appreciated by almost 50 percent against the dollar until it peaked in late 2010. This month the peso is only worth around half of that value.

Currencies in other countries such as Brazil, Colombia and Peru performed similarly well. Suddenly, the tide seemed to turn and the countries burdened by continuous crisis were faced with high foreign exchange reserves and seemingly stable economies, while investors in the US and Europe had to struggle with wide fluctuations.

Institutional investors increased their exposure to the emerging markets – not only because they were able to achieve higher yields there, but also because they seemed to be more stable. But nothing came of it.

Since the summer of 2008, the S&P 500 index has more than doubled, while the equity indices in emerging markets have barely made any progress.

What is disappointing from Chile’s perspective is that despite careful financial policy and the reputation of being a safe haven for international investors, it has not emerged.

However, Chile is not the only disappointment. In most other emerging markets, too, with a few exceptions, equities fell short of expectations.

The dream of BRIC remains a dream

When Goldman Sachs economist Jim O’Neill defined the term BRIC in 2001, referring to the potential in Brazil, Russia, India and China, the market was also under strong pressure.

But this was followed by years of recovery, which continued even after the collapse of Lehman Brothers in 2008. After the peak in late 2010, however, all emerging market indices except that of India fell sharply.

Now investors in seemingly safe countries such as Chile fear a referendum on the economic model. This does not augur well for the future and will certainly not help the emerging markets.

Without the confidence of international investors, it will be difficult to raise foreign capital to expand infrastructure. Intervention by central banks should help in the short term, but fund managers would rather keep their distance in the long run.

High inflation remains an issue

One of the main issues in many emerging market economies is that inflation has been higher than the respective central banks would admit. In Santiago alone, the subway fare has increased by almost 50 percent in just a few years, with the latest hike said to have triggered the recent riots.

With the rising cost of living, the operating costs of companies have also risen sharply, adversely affecting direct investments by international corporations, among other factors.

The Wall Street soothsayers expect foreign currency corrections to continue until costs are even further reduced to international standards levels. From this perspective, the pressure on the emerging markets is likely to persist for some time to come.