Mohamed El-Erian, a Managing Director with venerable fixed income fund manager PIMCO,
publishes his regular Emerging Markets Watch column on the fascinating topic of the difficulties in managing capital flows by governments or institutions. He simplifies it by relating it to the challenges of winning the lottery. I find emerging markets fascinating, mostly as it relates to how/why some countries succeed and others flail. His thoughts are concise:
For emerging countries, the literature on the “rentier state” has discussed the extent to which significant natural resources can undermine, rather than facilitate, nations’ management of their socio-economic development processes. And emerging countries do not have a monopoly here. Another influential strand of the natural resource literature has analyzed the “de-industrialization” of advanced countries under what was labeled in the 1970s as the “Dutch disease:” The phenomenon whereby the discovery of a depletable resource (such as oil and gas) can undermine existing industries, create unemployment problems, and undercut long-term growth potential.
He then dives in to the recent surge in EM capital flows and credits it due mostly to (a) some improved EM fundamentals (reflected in stronger domestic growth dynamics and improved fiscal governance) and (b) the “global carry trade” (reflecting investor search for yield along with US dollar worries). This co-existence of push and pull factors, as he calls it, result in significant surge in the flow of capital to emerging economies, with corresponding increases in international reserves. Imagine having to build a business where you had significant capital overhead and a credit line that was subject to the whims of your competitors' mis-steps...
For investors in the EM asset class, history suggests that, temptation aside, it is not enough to invest simply on the basis of the existence of large capital inflows. The manner in which these inflows are handled by policy makers around the emerging world will impact levels of absolute and relative returns from different instruments.
EM is a tough place to make money, especially in private equity. Not only do you have to make all the same difficulty strategic decisions that a US fund does, but you also have to take in to account global capital flows, sovereign risk, and fiscal governance -- not to mention the headaches from currency exchange.
