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2 Worst Performing Emerging Markets ETFs This Year

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The past few months have proved to be quite ugly for emerging markets investments. While in general, these markets had a lackluster performance earlier this year, investor sentiment deteriorated rapidly after the Federal Reserve hinted at scaling back its asset purchases.
India and Indonesia have been two worst sufferers of the reversal of investor sentiment. Popular ETFs tracking these markets like India Earnings Fund (EPI - Free Report) and MSCI Indonesia ETF (EIDO - Free Report) are down more than 20% year-to-date. In contrast, the broader iShares MSCI Emerging Markets ETF (EEM - Free Report) is down only about 7%. (Read: 3 Biggest ETF Winners from the 3rd Quarter)
Both these countries are dependent on foreign capital to fund their current account deficits, which will become difficult when the era of cheap money ends. Their dependence on foreign capital led to mass exodus of spooked foreign investors, leaving stock markets weak and currencies battered. At the same time, the crisis brought the macroeconomic fundamentals back in focus.
Macroeconomic Fundamentals Worsening
Indian economy recorded ~8% average growth rate during 2006-11 and Indonesia grew at an annual rate exceeding 5% in seven of the past eight years, mainly due to increasing consumption by their rising middle class. (See: 3 ETFs to Watch in October)
Both economies are now slowing down; Indian economy grew at just 4.4% in the last quarter, its slowest rate in a decade   while consumer price inflation in the country is close to 10% now.
Indonesia’s central bank revised the expected growth rate down to a range of 5.5 to 5.9% recently, as the country has been hit by slackening demand and weak prices for its commodity exports. Inflation continues to creep up in the Southeast Asian nation.
In the past couple of years both these economies benefited from their domestic focus; with consumption accounting for more than two-thirds of GDP, they were largely insulated from the global economic headwinds. Now as the recovery gains momentum in the developed world, emerging countries that are more geared to developed market growth are likely to perform better.
Deficits and Debt
While current account deficit has been a perpetual problem for India, Indonesia recorded a current account deficit in 2012 after 14 years of surplus.(Read: 4 Unbeatable Strategies for Q4)
India’s current account deficit which had grown to about 7% at the end of 2012 has moderated slightly this year; it was 4.9% of GDP during the first quarter of the current fiscal year. But, India’s short term debt has been growing.

With foreign exchange reserves at around $270 billion, India has a reserve coverage ratio (short term debt and current account defcit as a % of foreign exchange reserves) of about 1.1 times; slightly better than that for Indonesia.

Recent Measures Taken
The sudden flight of capital has left these central banks struggling to come up with appropriate policy responses to curtail the outflows and halt the currency slide. (Read:3 Sector ETFs to watch for the Budget Battle)
Indian central bank has taken a number of steps since the crisis started including a recent repo rate rise. Some of the market reforms proposals made by the new central bank governor raised hopes about the economy and the Rupee has recovered significantly since then.
Indonesia has raised its benchmark interest rate by 150 basis points since June. The central bank also intervened in the foreign exchange markets several times to halt the currency slide.
Indonesia’s trade account recoded a small surplus in August after a massive $2.3 billion deficit in July.  Further inflation also eased to 8.4% for September from 8.8% in August. These improvements suggest that the measures taken by the government to slow down the economy are finally working.
Other Roadblocks
Both countries suffer from structural problems like crumbling infrastructure, rampant corruption, and lack of political resolve to implement market reforms or curb populist subsidies. Further, economic nationalism has been on the rise in Indonesia. With elections due in both countries next year, any significant push to reforms or to curb populist measures like ballooning subsidies should not be expected anytime soon.
Is the Worst Over?
Both these countries have stabilized and worst may be over for now but they are definitely not out of the woods. There may be another round of panic for these markets when the taper talk returns. Even after the recent recovery, Indian Rupee is down about 12%, whereas Indonesian Rupiah is down almost 16% year to date. 
Several steps taken by India to curb gold imports---which account for a large part for the trade deficit, may help the current account going forward. Further a cheaper Rupee works well for exporters in India, specially IT exports. On the other hand, Indonesia’s exports are largely dollar denominated and thus do not benefit from a cheaper Rupiah.
Raghuram Rajan, the new governor of the Reserve Bank of India aptly cautioned “let us remember that postponement of tapering is only that – a postponement…..we must use this time to create a bulletproof national balance sheet and growth agenda that creates confidence in investors…”.
So unless these countries take solid measures to contain their deficits and spur growth as well as introduce substantial structural reforms, their markets will remain vulnerable to tapering fears.
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