Emerging Markets Hit by Converging Forces

Updated July 1, 2013, 9:15 p.m. ET

Emerging Markets Hit by Converging Forces

ALEX FRANGOS in Hong Kong and PATRICK MCGROARTY in Johannesburg

Countries from Turkey to Brazil to China are getting hit by a brutal combination of events, as economies slow, investors pull out cash, commodity prices tumble and protesters take to the streets—all fresh reminders that these markets can be difficult places to try to make money.

An outflow of funds from so-called emerging markets has picked up pace over the past month, triggered by expectations among some investors that the days of easy money globally are coming to an end as the U.S. economy recovers.In China, a central bank-induced credit squeeze is adding to concerns its economy will slow further, and that is spilling over to other countries. While the liquidity crisis showed signs of easing on Monday, weak manufacturing data in China added more gloom to the sentiment.

Last week, outflows from emerging-market bond mutual funds more than doubled compared with the week before, to nearly $6 billion. That makes the past five weeks the largest uninterrupted selloff since 2009, according to data provider EPFR. In a sign of how strong inflows were before the recent slide, net flows for the year remain in positive territory, around $10 billion.

“Back in April, emerging markets were the best thing since sliced bread. Two weeks ago they were toxic,” said Jan Dehn, head of research at Ashmore Investment Management Ltd., an emerging markets specialist with $77.7 billion in assets under management.

It is a stark turnaround for these countries, whose growth helped offset weakness in the U.S. and Europe during the financial crisis. Seeking better returns, investors poured money into emerging-market economies in the past four years.

Private capital flows into emerging markets from 2009 to 2012 were $4.2 trillion, according to the Institute of International Finance, a banking-industry group, more than all the money invested in the Tokyo Stock Exchange.

While the amount of money leaving these markets hasn’t reached levels seen during the 2008 crisis, the outflows are expected to continue as sentiment sours further.

“All the markets, everything went down,” said Aliko Dangote, the Nigerian cement mogul and Africa’s richest businessman, as he waited to hear President Barack Obama address an audience in Soweto, outside Johannesburg, on Saturday. “Money doesn’t have borders right now.”

The coordinated emerging-market selloff has reminded some investors of past panics, when rising U.S. interest rates triggered or exacerbated economic and political turmoil abroad. Mexico’s debt crisis in 1994 and the Asian financial crisis of 1997, which spread from Southeast Asia to Korea to Russia, fit into that category.

Few predict the current situation will morph into a new global panic. Emerging markets, with a few exceptions, are in better position today to withstand economic shocks, with mountains of foreign-exchange reserves and less reliance on foreign currency-denominated debt, a key ingredient that made the 1997 Asian crisis so severe.

While debt levels have risen in recent years, especially in Asia, banks remain well-capitalized. And unlike in the developed world, governments have relatively low debt burdens and have the capacity to backstop a sliding economy with public spending.

Emerging-market economies likely will collectively grow around 4% in the second quarter, the slowest rate since 2009 and well below the average of the past decade of close to 7%, according to London-based research group Capital Economics.

In recent weeks, China, which had boosted growth in many of these economies, has become a burden. The country’s central bank mounted a campaign to stamp out what it sees as dangerous lending in recent weeks. That forced short-term interest rates up, signaling a further slowdown in economic growth. Shanghai’s stock market hit its lowest level since 2009.

Once bullish economists, such as Hongbin Qu of HSBC, HSBA.LN +1.86% now figure China could grow as slowly at 7.4% this year and next, a major shift down from the past decade when China often grew at a 10% clip.

The slowdown can be seen in electricity consumption, which grew just under 5% through May this year, after growing double digits for much of the past decade. Electricity-generation equipment maker Harbin Electric Co. 1133.HK -3.70% said last week customers have cancelled and delayed orders that would cause a “substantial decrease” in profit in the first half of the year.

The effect of a slower China has ricocheted globally to mining-equipment manufacturers and raw material suppliers, such as copper producers in Chile and coal miners in Indonesia.

Australia’s Seven Group Holdings Ltd. SVW.AU -2.12% said Friday it will cut around 350 jobs from its WesTrac heavy machinery unit, in response to the slowdown in coal mining to supply China. WesTrac is the sole distributor of Caterpillar equipment in Australia’s big mining states.

Even Zeeland, Mich., office-furniture maker Herman Miller Inc. MLHR +1.63% said its sales in Australia have gone soft as the country’s mining boom has stalled.

“As the other parts of the emerging markets are not using as much raw materials, you’re just seeing the general activities levels in Australia drop,” said Brian Walker, Herman Miller’s chief executive in a conference call with investors.

China is Brazil’s largest trading partner, and a drop in prices for iron ore and oil have contributed to anemic growth in the Western Hemisphere’s second-largest economy. Brazil’s stock market has fallen 22% this year, losses made worse by the nearly 10% drop in the value of its currency, the real.

Brazilians have poured out onto the streets in recent weeks, in huge demonstrations that have sometimes turned violent. The protests were triggered by an increase in public transportation fares, which tapped into frustration about rising costs amid a stumbling economy.

In India, the downturn comes amid stalled economic steps. Stubborn inflation and a swelling deficit have hampered growth. The Indian currency, the rupee, fell to an all-time low against the dollar in June.

In Turkey, which has struggled with weak growth in Europe, markets were hit by the talk of the Fed exit. Layered on that was political unrest, sparked by a controversial plan to demolish a park in central Istanbul. Istanbul’s stock index was down 11% last quarter, while the dollar has strengthened 9% against the lira over the same period.

The South Africa economy is suffering from labor strikes and weak gold prices. The currency, the rand, has lost 20% of its value this year against the dollar, feeding an already stubborn inflation problem and hampering the ability of the central bank to cut rates to stimulate growth.

The emerging market selloff could end up choking off credit used for critically needed infrastructure development in Africa. Several African countries, including Zambia, Rwanda, and Tanzania took advantage of the emerging-markets boom to raise money in international credit markets at rates lower than in some developed countries.

Last week, Nigerian officials wrapped up presentations to investors in the U.S. and Europe for a potential $1 billion bond. But investors were wary and the government put the plans on hold.

“That window of really attractive financing terms, that’s probably gone, and African governments are going to have to think more realistically about how much they rely on external debt,” says Razia Khan, head of Africa research at Standard Chartered.