In February, rating agency Fitch downgraded its outlook for Iceland’s government debt from "stable" to
"negative," citing a "material deterioration in Iceland’s macro-prudential risk
indicators, accompanied by an unsustainable current account deficit and soaring
net external indebtedness." While all the signs of economic overheating were
evident for some time, Fitch said the rate at which some of these indicators
deteriorated exceeded the agency’s expectations.
 Thus began a minicrisis in emerging-market debt. Iceland’s
currency went into free fall, plummeting 10 percent almost overnight, and
speculators who had borrowed in lower-yielding currencies to invest in the
higher-yielding Icelandic krona-denominated debt (a technique called a "carry
trade") were left struggling to unwind their positions in an increasingly
illiquid market. As they sought to sell more-liquid currencies to raise cash, it
caused other emerging-market paper, such as the Brazilian real and South African
rand, to suffer.
By March, people started to wonder if the Icelandic angst was a
portent of things to come in other emerging markets. But the consensus view
among professional emerging-market investors is that it is not. "This is a
country that has high interest rates for a reason, and that is that it has very
poor economic fundamentals, which is not the case with the vast majority of
emerging markets," says Aberdeen Asset Management’s Edwin Gutierrez. "The vast
majority of emerging markets are running current account surpluses and run a
tight fiscal ship."
Indeed, the fact that the Iceland sell off only slightly
affected emerging-markets currencies could be a good sign for investors. "Years
ago that situation would have affected the entire asset class, but now I think
investors have become more sophisticated and there’s more money in the asset
class, so those situations tend to be isolated," says Jim Barrineau of
AllianceBernstein.
Art by Stephen Webster.
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