Don't worry about waning EM foreign reserves, says Mark Mobius

The International Monetary Fund reported that total currency reserves in emerging markets fell in aggregate by $114.5bn (£75bn) on a year-on-year basis to $7.74 trillion in 2014, down from their peak of just over $8 trillion in the second quarter of 2014.

With foreign reserves historically used by emerging markets to meet international payment obligations, cushion against unforeseen shocks and provide substantial credit to developed market debt, many have expressed concern over the trend.

But Dr Mobius says emerging markets still look more appealing than developed countries due to more favourable demographics and stronger rates of economic growth and points out that foreign reserves are still substantial enough to meet external financing needs in most markets.

At $3730bn, China's foreign reserves are more than enough to match its external finance needs of $268bn, according to IMF data, and India's foreign reserves make up 272 per cent of its $115bn external financing needs.

An exception to that is Ukraine, where foreign reserves have been plunging. In February 2015 reserves hit record lows, falling by 14 per cent to just $6.42bn - $5.4bn in actual liquid foreign currency terms. They now stand at $5bn according to data provided by Templeton Emerging Markets, sourced from Bloomberg and the World Bank, meaning just 11 per cent of the country's $41bn external financing needs are covered by foreign reserves.

Dr Mobius points out that FX reserves remain still four times as high as in 2004.

He argues that, added to that increased FX buffer over the past 10 years, emerging markets are now less reliant than ever on large reserves for monetary policy. Emerging markets central banks have grown ever more independent in recent years, taking on responsibility for controlling inflation and setting interest rates domestically, erasing the need for a foreign reserve 'war chest'.

So far in 2015 they have also delivered stellar results, with the MSCI Emerging Markets index returning 13.63 per cent in the year to date. However, TEM has failed to match that performance, returning just 5.29 per cent. The share price is up 253.5 per cent over 10 years compared with 196.4 per cent for the MSCI Emerging Markets. But it has failed to keep up that momentum over a one-, three- and five-year period and has underperformed the index.

Dr Mobius says Brazil, South Africa and Pakistan were among the largest detractors in March 2015, with corruption investigations in Brazil and anti-government protests taking a toll on the market. The fund is 11.1 per cent exposed to the region after adding to investments in the country during the first quarter of 2015 due to attractive fundamentals. It also has 4.1 per cent of its holdings in Pakistan.

But the manager is expecting a pick-up in Brazil as a result of the end of Brazil's corruption probe and geopolitical tensions.

Adequacy of emerging market foreign exchange reserves for financing needs

Source: Templeton Emerging Markets, IMF, Bloomberg, World Bank

Performance (% total return) of Templeton Emerging Markets' share price against benchmark

Source: FE Trustnet, as at 5 May 2015