Investor sentiment towards emerging markets remains bleak.
Emerging market stocks have lost 10% in dollar terms this month, resulting in a 20% decline over the past three months. In the period between Aug. 19 and 26, emerging market bond funds suffered outflows of nearly $4.2 billion, according to J.P. Morgan. This represents the second-largest volume of weekly redemptions on record and a significantly larger outflow than in February 2014 when fears about the fallout from the end of the U.S. Federal Reserve's quantitative easing program roiled markets.
Since the bursting of China's stock market bubble in late June, and particularly since the surprise devaluation of the yuan on Aug. 11, concerns have shifted away from the effects of a tightening U.S. monetary policy and towards policy uncertainty and economic weakness in China.
While the sharp fall in the prices of raw materials -- the third key factor behind the emerging markets sell-off -- stems partly from the resurgence of the dollar in anticipation of an increase in U.S. rates, China's economic and financial woes have pulled the rug out from under commodity markets.
Make no mistake, China is now the focal point of investor nervousness about emerging markets.
Mounting fears about Beijing's ability to restore confidence in China's stock market and, more importantly, rebalance and reform the country's rapidly slowing economy are a game-changing development for markets.
Comparisons between the current sell-off in emerging markets and the full-blown crises in the 1990s are misleading. The underlying fundamentals of developing economies, particularly in Asia, are much stronger this time round, while the risk of a systemic liquidity and solvency crisis is significantly lower.
However, the stakes are much higher this time. The size of China's economy is now on par with that of the U.S. in purchasing power parity terms, according to the International Monetary Fund.
Previous emerging market crises originated in countries whose economies were much smaller than China's as a share of global gross domestic product. Mexico, which triggered an emerging market sell-off in 1994, accounted for just 2% of global output, while the five countries at the center of the 1997-98 Asian financial crisis accounted for less than 5% of world GDP.
A sustained China-induced sell-off would be highly damaging, particularly at a time when the global recovery is sputtering and when the Fed is preparing to raise rates for the first time since 2006.
Despite a partial rebound in global equity markets, including China's, the benchmark Shanghai Composite index is still 37% down since the peak of the bull market on June 12.
China's stock market rout has shone a spotlight on the deep-seated problems confronting the country's policymakers. And there is ample scope for a much sharper deterioration in sentiment if markets lose faith in the government's ability to manage and reform China's rapidly slowing economy.
Beijing's ineffective, confused and poorly communicated policy response has already exacerbated the emerging markets sell-off and has led investors to pare back their expectations regarding the timing of a rise in U.S. rates.
Yet any boost to sentiment from a delay in the tightening of U.S. monetary policy would be nullified if fears about China morph into panic.
A loss of faith
Beijing's ineffectual effort to shore up the domestic stock market and confusion about its policy toward the yuan, which remains significantly overvalued, hardly inspire confidence in the authorities' ability to manage the much bigger problems facing the country.
China is suffering from a severe case of "policy overload' as it pursues several goals that are worryingly at odds with each other. The authorities are trying to rebalance the economy away from investment and towards consumption, implement financial reforms, sustain an unrealistically high growth rate and safeguard the authority and economic competence of the Communist Party.
China's woes, moreover, pose a dilemma for the Fed which had been poised to raise interest rates next month. Now, a September "lift-off" is perceived as increasingly unlikely.
Yet if the Fed keeps its policy rates at zero, this could exacerbate fears about China's economy and financial markets.
The "China factor" looms large in the minds of investors and central bankers.
Nicholas Spiro is the founder and managing director of Spiro Sovereign Strategy, a London-based consulting company that specializes in sovereign credit risk.