The summer of market discontent in the wake of expectations that the US Federal Reserve would start to scale back its massive monetary stimulus, only made too clear the need for the governments of emerging economies to start getting serious about domestic reforms.
As expectations rise again that the Fed could “taper” as soon as this month, the “fragile five”, economies identified by Morgan Stanley as particularly vulnerable due in part to large current account deficits, are once more in focus.
The central banks of Brazil, India, Indonesia, South Africa and Turkey have been busy hiking rates to counter plunging currencies. But governments have yet to tackle the difficult domestic reforms, including tax and labour, to free up their economies and attract the long-term investment they need – not least as all five face elections in 2014.
Brazil: By Joe Leahy in São Paulo
Four years ago, Lucimara Tavares’ ex-husband ran off, leaving a R$12,000 loan in her name. That has since swollen to R$60,000 ($26,000) as Brazil’s rates on consumer loans can be anything up to three figures.
“The interest rates only rise and my salary doesn’t keep pace,” Ms Tavares says during a visit to the debt agency Serasa in São Paulo. “I’ve already come to terms with the fact that I will never manage to pay this off, I will pass the rest of my life trying to renegotiate it.”
Her situation is difficult, but these last few years have been the easy ones. If and when the Fed tapers, the flow of easy global liquidity that has driven Brazilian interest rates down to historic lows but are now back in double digits, will affect everyone from the government to borrowers like Ms Tavares (credit to the private sector in Brazil doubled in five years to 50 per cent of gross domestic product).
The summer turmoil from earlier expectations for a scaling back of US stimulus has already exposed the imbalances that have been building up in the economy but it did not prompt Brasília to address them. They range from a growing government budget deficit to official attempts to control inflation by curbing rises in the price of items such as fuel. They will have to be allowed to correct themselves, probably leading to a weaker currency, higher inflation and higher interest rates.
The government is expected to try to prevent this happening in 2014 when there is a presidential election. But whether markets will be that patient is another matter – Brazil is heading for credit downgrade and the government could face political protests during the World Cup. “Whoever wins the 2014 elections will have to deliver adjustments in order to regain business confidence and boost investments,” Barclays said.
India: By James Crabtree in Mumbai
Arguably the emerging market most severely affected by previous investor “taper” anxiety, the looming Fed decision threatens to spoil a subsequent recovery in the rupee and the stock market.
Indian stocks hit an all-time high last week, buoyed by hopes over a potential change of government in next year’s national elections that investors anticipate will make the country more pro-business, buoying optimism for a possible turnround in Asia’s third-largest economy.
Fears over the impact of the taper have been allayed in particular through moves by Reserve Bank of India head Raghuram Rajan to continue a severe clampdown on gold imports alongside the unexpected success of a scheme designed to attract savings investment from Indian expatriates.
“Control of gold and the inflow of diaspora money has built a clear $60bn buffer, and because of this the taper will probably be relatively benign, unless it is unexpectedly large, and leads to a big spike in US 10-year bond yields,” says economist Chetan Ahya at Morgan Stanley.
A forceful move by the Fed could overturn India’s mild recovery. A slender pick-up in growth to 4.8 per cent in the third quarter has been soured by a series of dismal data, most recently on rising inflation and falling industrial production last week. “India hasn’t solved its problems, it has just bought some time with these inflows. It will have to do more when they begin to get used up in three to six months time,” Mr Ahya added.
Turkey: By Daniel Dombey in Ankara
Ankara’s reaction to the prospect of the taper? “Bring it on.” This is despite the summer turmoil. The question is whether such bravado is a worrying dismissal of fundamental weaknesses that distinguish Turkey even among the “fragile five”.
Ibrahim Turhan, the head of Istanbul’s stock exchange, argues that where funds are scarcer, markets with strong fundamentals – for him, Turkey – stand out. Mehmet Simsek, finance minister, argues the summer turmoil means the markets have already adjusted to the prospect of less easy money and that investor dollars now buy more local assets, with higher returns.
Some investors say that the initial impact of any US Fed announcement may be small, particularly if it is accompanied by strong “forward guidance” about keeping interest rates low. But the strength of Turkey’s underlying economic position is contentious.
It may have healthy levels of government debt and a small fiscal deficit, particularly compared with Indonesia and Brazil, but stands out for its dependence on hot money, giving it a less enviable position. More than 80 per cent of the current account deficit (some 7.5 per cent of GDP) is underwritten by short-term funds rather than foreign direct investment. Meanwhile, some companies have accumulated high levels of short-term foreign currency debt.
Turkey may be exposed to perceptions of political risk at a time when not just tapering, but the country’s first presidential election on the horizon and internecine fighting in the coalition is accompanied by a criminal investigation into politically-connected figures. This could make tackling structural weaknesses – including a low level of labour participation and a sliding savings rate – even less likely.
South Africa: By Andrew England in Johannesburg
Leave the prospect of tapering aside, Africa’s largest economy is beset with domestic problems and a gloomy outlook that an outflow of capital will only exacerbate.
Economic growth is at its worst since its 2009 recession, compounded by strikes, with 25 per cent unemployment and high poverty rates. Analysts forecast GDP to dip just below 2 per cent this year, down from a peak of 5.6 per cent in 2006. It is also struggling with a widening current account deficit that has reached 6.8 per cent.
Pravin Gordhan, finance minister, said earlier this year that it was important that there is greater clarity and communication from the US around tapering to negate potential shocks. But he also acknowledged that emerging markets must also “lift our game,” to reduce deficits and create a climate of confidence. To that end, the government has been meeting with business leaders as it seeks ways to improve confidence and exports.
Despite the headwinds, Mr Gordhan has been credited with keeping government expenditure growth an annual average of 2.2 per cent over the next three years, even though the ruling African National Congress faces elections next year.
But analysts say they want to see more measures to cut wasteful expenditure and more substantive efforts to boost growth and exports, and reducing the deficits.
Indonesia: By Josh Noble in Hong Kong
The central bank has raised benchmark interest rates by 175 basis points since June, in part to slow the capital outflows in the summer that had put severe pressure on the rupiah. Its current account widened to its worst since the Asian crisis of the late 1990s.
Despite the higher rates, the rupiah is at a record low. The weaker currency should help achieve the goal of bringing the current account deficit back down to around 2.5 per cent of GDP next year as exports become more competitive, from the 4.4 per cent this year. Economists say the higher borrowing costs should also soon help to slow demand for imports and further cut the deficit.
However, some say more needs to be done to stabilise the economy once tapering begins. The impact from further outflows is large given around a third of government debt is owned by foreigners. The World Bank recently cut its growth forecast for 2014 to 5.3 per cent, compared to 6.3 per cent in 2012. And like India, Indonesia is due to have national elections this year, which have dimmed the near-term prospects for much-needed structural reform.
With additional reporting by Valentina Romei in London