Investors and hedge funds withdraw capital from risky assets

Although sharp losses are recorded on stock exchanges around the world today, the hardest hit are the stock markets of developing countries, such as Hungary, Turkey, China, and others, due to the withdrawal of capital by investors, primarily hedge funds, from risky assets.

European stock exchanges are down more than four percent today, and a poor start is expected on Wall Street, especially after Wachovia Corp. reported a record loss in the third quarter of as much as $23.9 billion. However, due to the withdrawal of capital from riskier assets worldwide, the greatest losses are suffered by stock exchanges in developing countries. “Investor aversion to risk has intensified. Markets in developing countries are beginning to collapse; this means that the recovery of the global economy will be significantly more difficult,” says Peter Mueller, a strategist at Germany’s Commerzbank.

The MSCI index of stocks in emerging markets has plunged about 4.5 percent today, to its lowest level since June 2005. This is significantly more than the decline of the MSCI index of stocks on global exchanges, which weakened by 2.45 percent today. “The fundamentals in emerging markets have not changed. It is about capital being withdrawn from developing countries to developed countries,” explains Neil Dougall, an economist at Dresdner Kleinwort.

Due to the sudden withdrawal of capital, there is increased pressure on the exchange rates of the national currencies of these countries. The Hungarian forint has been the hardest hit so far, but others are also recording declines against the dollar and the euro. Thus, the Turkish lira has fallen to its lowest level against the dollar in the last two years, as has the Russian ruble, and the South African rand in the last six years. To defend the forint, Hungary’s central bank raised the key interest rate today by three percentage points, to 11.5 percent. This temporarily lifted the forint’s exchange rate against the euro from its lowest level in more than two years. However, the forint is down 15 percent against the euro since the beginning of the month.

It is possible that other central banks in developing countries will take drastic measures like Hungary’s to stop the sharp decline in their currencies’ exchange rates, but analysts warn that this will have drastic consequences for the economy. “Investors are selling off the currencies of developing countries for fundamental reasons and not because of interest rates. Moves like Hungary’s only create panic, and of course, higher interest rates make it harder for the population to repay loans,” notes Nigel Rendell, a strategist at the Royal Bank of Canada.

Furthermore, Hungarian officials signaled today that they are in negotiations with the IMF. The central monetary authority in Belarus has requested a loan from the IMF worth $2 billion, while Ukrainian Prime Minister Yulia Tymoshenko stated that she expects the IMF to decide on a loan for Ukraine during the day. The IMF is already helping Pakistan and Iceland avoid financial collapse.

Global demand for raw materials is also rapidly weakening. The world’s leading mining company, BHP Billiton, warned today that Chinese demand is significantly weakening. China reported on Monday that its industrial production in September fell to its lowest level in the last six years. “China is not immune to the global slowdown in activity. We expect continued volatility and uncertainty in the short term,” the company stated. Just last week, its rival, Rio Tinto, warned of this.

With weakening demand, raw material prices are also falling. Thus, the price of oil today on the New York market plunged below $70 per barrel, while the futures price of copper dropped by 5 percent, to $4,270 per ton, its lowest level since December 2005. Just in July, the price of this metal, which is intensively used in construction and the electrical industry, was $8,940. The futures price of a ton of aluminum on the London Metal Exchange fell to $2,057, lead to $1,285, zinc to $1,144, while the price of nickel fell to $11,510 – the lowest level since January 2007. “Demand forecasts for metals are bleak, which is why the performance of the metals market is poor,” says Lin Hui, an analyst at Orient Futures Securities.

The decline in commodity prices and the withdrawal of capital from the stock exchanges of developing countries has spurred the rise of the US dollar to its highest level in the last two years against a basket of the most important international currencies. Against the British pound, the dollar strengthened by almost three percent today, to its highest level in the last five years, with the pound standing at $1.6203. As safe assets suddenly come into vogue, euro-denominated bonds have also become more expensive today. This has lowered the yield on 10-year euro-denominated bonds to its lowest level in the last week and a half. (H)