Investors warned on emerging market risk

Investors and lenders in emerging markets may be underestimating the risks, Bill Rhodes, vice-chairman of the Institute of International Finance, said on Tuesday.

Mr Rhodes, a senior Citigroup banker who was involved closely with Latin America’s external debt restructurings of the 1980s and 1990s, said that economies in Latin America had become much sounder in recent years but recent steep rises in local financial markets owed much to the abundance of capital inflows.

“Governments need to remain vigilant in pursuit of policies that reinforce investor confidence. The days of easy money are over,” Mr Rhodes told the annual meeting of the Inter-American Development Bank in Belo Horizonte, Brazil.

Latin American markets have been among the world’s best performing stock and bond markets over the past year or so, with currencies strengthening and yield spreads on dollar bonds at all-time lows. The yield spread on emerging market debt over US Treasuries has fallen from 10 percentage points in October 2002 to less than 2 percentage points today, according to the JPMorgan EMBI+ index, while the MSCI emerging equity markets index has almost trebled over the same period.

But Charles Dallara, managing director of the IIF, said: “We shouldn’t assume that ratings and prices are a guarantee of underlying fundamentals.”

Mr Rhodes said: “We are in a situation similar to that which existed in the spring of 1997, when threats existed to market stability and a lot of people didn’t want to see it. I am not predicting a new Asia crisis but it is interesting to see the similarities that are present. There is a need for lenders and investors to be prudent.”

Mr Rhodes was particularly concerned that the risks attendant on global imbalances such as the sizeable US current account and fiscal deficits and the possibility of slower global growth could have damaging consequences for emerging markets.

The IIF was urging its members, which include the world’s biggest banks and financial institutions, to be “very careful”, he said.

Mr Rhodes said the IIF was particularly concerned about the risks faced by small retail investors attracted by the high returns. Small investors from Japan and Europe were big buyers in the 1990s of high-yielding Argentine bonds and were hit by the country’s debt default in 2001.