Friday, August 22, 2014

The Trouble with Emerging Markets

LAGOS – The financial turmoil that hit emerging-market economies last spring, following the US Federal Reserve’s “taper tantrum” over its quantitative-easing (QE) policy, has returned with a vengeance. This time, the trigger was a confluence of several events: a currency crisis in Argentina, where the authorities stopped intervening in the forex markets to prevent the loss of foreign reserves; weaker economic data from China; and persistent political uncertainty and unrest in Turkey, Ukraine, and Thailand.

This mini perfect storm in emerging markets was soon transmitted, via international investors’ risk aversion, to advanced economies’ stock markets. But the immediate trigger for these pressures should not be confused with their deeper causes: Many emerging markets are in real trouble.

The list includes India, Indonesia, Brazil, Turkey, and South Africa – dubbed the “Fragile Five,” because all have twin fiscal and current-account deficits, falling growth rates, above-target inflation, and political uncertainty from upcoming legislative and/or presidential elections this year. But five other significant countries – Argentina, Venezuela, Ukraine, Hungary, and Thailand – are also vulnerable. Political and/or electoral risk can be found in all of them, loose fiscal policy in many of them, and rising external imbalances and sovereign risk in some of them.

Then, there are the over-hyped BRICS countries, now falling back to reality. Three of them (Brazil, Russia, and South Africa) will grow more slowly than the United States this year, with real (inflation-adjusted) GDP rising at less than 2.5%, while the economies of the other two (China and India) are slowing sharply. Indeed, Brazil, India, and South Africa are members of the Fragile Five, and demographic decline in China and Russia will undermine both countries’ potential growth.

The largest of the BRICS, China, faces additional risk stemming from a credit-fueled investment boom, with excessive borrowing by local governments, state-owned enterprises, and real-estate firms severely weakening the asset portfolios of banks and shadow banks. Most credit bubbles this large have ended up causing a hard economic landing, and China’s economy is unlikely to escape unscathed, particularly as reforms to rebalance growth from high savings and fixed investment to private consumption are likely to be implemented too slowly, given the powerful interests aligned against them.

Moreover, the deep causes of last year’s turmoil in emerging markets have not disappeared. For starters, the risk of a hard landing in China poses a serious threat to emerging Asia, commodity exporters around the world, and even advanced economies.

At the same time, the Fed’s tapering of its long-term asset purchases has begun in earnest, with interest rates set to rise. As a result, the capital that flowed to emerging markets in the years of high liquidity and low yields in advanced economies is now fleeing many countries where easy money caused fiscal, monetary, and credit policies to become too lax.

Another deep cause of current volatility is that the commodity super-cycle is over. This is not just because China is slowing; years of high prices have led to investment in new capacity and an increase in the supply of many commodities. Meanwhile, emerging-market commodity exporters failed to take advantage of the windfall and implement market-oriented structural reforms in the last decade; on the contrary, many of them embraced state capitalism, giving too large a role to state-owned enterprises and banks.

These risks will not wane anytime soon. Chinese growth is unlikely to accelerate and lift commodity prices; the Fed has increased the pace of its QE tapering; structural reforms are not likely until after elections; and incumbent governments have been similarly wary of the growth-depressing effects of tightening fiscal, monetary, and credit policies. Indeed, the failure of many emerging-market governments to tighten macroeconomic policy sufficiently has led to another round of currency depreciation, which risks feeding into higher inflation and jeopardizing these countries ability to finance twin fiscal and external deficits.

Nonetheless, the threat of a full-fledged currency, sovereign-debt, and banking crisis remains low, even in the Fragile Five, for several reasons. All have flexible exchange rates, a large war chest of reserves to shield against a run on their currencies and banks, and fewer currency mismatches (for example, heavy foreign-currency borrowing to finance investment in local-currency assets). Many also have sounder banking systems, while their public and private debt ratios, though rising, are still low, with little risk of insolvency.

Over time, optimism about emerging markets is probably correct. Many have sound macroeconomic, financial, and policy fundamentals. Moreover, some of the medium-term fundamentals for most emerging markets, including the fragile ones, remain strong: urbanization, industrialization, catch-up growth from low per capita income, a demographic dividend, the emergence of a more stable middle class, the rise of a consumer society, and the opportunities for faster output gains once structural reforms are implemented. So it is not fair to lump all emerging markets into one basket; differentiation is needed.

But the short-run policy tradeoffs that many of these countries face – damned if they tighten monetary and fiscal policy fast enough, and damned if they do not – remain ugly. The external risks and internal macroeconomic and structural vulnerabilities that they face will continue to cloud their immediate outlook. The next year or two will be a bumpy ride for many emerging markets, before more stable and market-oriented governments implement sounder policies.

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  1. Portrait of Pingfan Hong

    CommentedPingfan Hong

    "particularly as reforms to rebalance growth from high savings and fixed investment to private consumption are likely to be implemented too slowly":this so-called "rebalancing" is exactly the cause of slowdown in growth.

  2. CommentedCengiz Akis

    In Turkey, the budget deficit to GDP ratio has been 1.2% in 2013 (was 24 % in 2004), the same figure is around 5.1% in India; 3% in Brazil and 4.8% in South Africa. By the way, 2013 budget deficit (1.2%) is also the lowest ratio in the last 40 years for Turkey. If we look at the state debts to GDP ratio, again we notice that Turkey is standing on a very strong ground, with a figure of 35% in 2013 (was 95% in 2004), with respect to, for example Greece (168%), Japan (244%), UK (92%), Italy (128%) and Germany (81%). Considering that almost all crises in the past were triggered by public debts and budget deficits in Turkey, any analysis, math-model or forecast which does not take the low state debts and low budget deficit into account, would surely be badly wrong about this country. Moreover Turkish state does not have short term foreign debts. Recently, the Turkish treasury-bonds with a total value of 2.5 billion $ and 5.75% interest rate were sold, and the demand from all over the World was four fold bigger than the supply; revealing the international trust. The much discussed current account deficit in Turkey, is not such a critical problem in reality. Because, it is mostly oriented in profit allocation among foreign divisions within, Turkish private sector corporations. As it is widely known, transfer pricing is the major tool for corporate tax avoidance, and it creates current account deficit when a multinational company receives from its own branch abroad, the previously transferred own profit, as a debt. As a result, to expect an economic crisis in Turkey under these conditions, seems to be highly unrealistic. Simply because, Turkey is not fragile.

  3. CommentedPatrick Signoret

    "the Fed has increased the pace of its QE tapering"
    This is a strange way of saying it, equivalent to "the Fed is increasing the pace at which it is decreasing its pace of asset purchases". I'm don't think that I could deny that this is not far from confusing. Plus, I don't think it's accurate. So far, the Fed has tapered twice, both times by $10 bn/month.

  4. CommentedSegun Zack

    Mr Roubini has provided a good perspective on EMs. However, I think he should have expanded the spectrum to cover Nigeria where he appeared to have written the piece from to further underscore the point of taking a differentiated view to emerging markets. Nigeria has been classified as part of MINT (others include Mexico, Indonesia and Turkey) and likely to surpass South Africa in economic size when the GDP rebasing is completed early this year.

  5. CommentedProcyon Mukherjee

    Mr. Roubini has given a very balanced view on the commentaries that have been deriding the emerging market conundrum as an event of abstraction, but we should note that these events are not unconnected from the overall global economic issues influenced by Central bank policies that are uncoordinated. It is unsettling that the EM, which is supposed to be the growth epicenters as per the reports of almost every bank, every economist or every blog, is suddenly being relegated from being the cynosure to being the outcast, which actually does not bode well with the fortunes of those in the developed world, who have to find markets for their produce and their capital to fly to when returns falter in other markets.

    Structurally nothing has changed in the non-EM world, nor the little change that we have seen leaves an imprint of permanence; fragility is common everywhere, why single out the Fragile Five?

      CommentedKen Fedio

      Oh, that's easy. He collects a paycheque in NY-NY. Only guys like Stiglitz and Krugman can call them like they see them, and even they have to water-down their innermost, I think. If you're from beyond the pale you communicate in deep thoughts and silences.

  6. CommentedGe Malagaris

    "As mass production has to be accompanied by mass consumption, mass consumption, in turn, implies a distribution of wealth ... to provide average people with buying power. ... Instead of achieving that kind of distribution, a giant suction pump had drawn into a few hands an increasing portion of currently produced wealth. ... The other fellows could stay in the game only by borrowing. When their credit ran out, the game (and the economy) stopped."

    No this text is not about the 1% of today, but about 1929 when we had a similar situation. Marriner Stoddard Eccles was known during his lifetime chiefly as having been the Chairman of the Federal Reserve under President Franklin Delano Roosevelt.

    find me at

      CommentedRichard S. Stone

      That is made clear from the housing boom of 2003-2006, when borrowing took the place of earning. Clearly an unsustainable borrowing. The next question is whether the 1% have sufficiently isolated themselves from the impending decline. And whether their work is productive enough to continue when things decline. My favorite line in this regard is from some description of the Philippines in the last systemic collapse, that being closer to the bottom it could not go down as much, no matter what.

      CommentedClaude Simon

      You are right, and if they go too far, everybody should be allowed to become his own banker.