By Ian Fraser
In the aftermath of the global financial crisis, and especially during the eurozone crisis of 2010-12, the emerging markets seemed like a reliable, steady and ethical engine that was capable of rescuing the traumatized developed world. However, since last summer, that engine has been showing disturbing signs of weakness. It has been misfiring, stalling, and even in some places grinding to a halt.
Many politicians and central bankers in the emerging economies like to blame their favorite bogeyman – the US Federal Reserve – for their travails. With its series of quantitative easing (QE) programs, inaugurated under former Fed chairman Ben Bernanke in November 2008, the United States flooded capital markets with cheap money for five years, fueling an emerging market boom. There were some, including Chinese commentator Andy Xie, who predicted QE would bring global conflagration.
However the money printing program had to end some time. There have been warnings from the Fed since May 2013 and, in January, the intravenous injections of cash started to be reduced. This has had the effect of sucking investment out of the emerging economies, depriving them of the essential nutrient that fed much of their post-crisis credit success. Some of the emerging markets have been able to take this in their stride. But others – generally the more fiscally feckless ones, jurisdictions that have current account deficits, and which became dependent on "hot" international money to paper over domestic inadequacies – have found the reversal of the financial tide harder to bear.
Nouriel Roubini, economics professor at New York University Stern School of Busines, believes that the "Fragile Five" emerging economies (Brazil, India, Indonesia, South Africa and Turkey) – three of which are also BRICS – are vulnerable to potential Armageddon. He said:
"All five have both fiscal and current account deficits, diminishing growth rates, above-target inflation, and political uncertainty as a result of forthcoming legislative and/or presidential elections this year."
He said five further emerging markets – 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.”
It is tempting for politicians and central bankers in such countries to lash out at the Fed and blame all their woes on Bernanke and his recently installed successor Janet Yellen. The specter of callous western "financial imperialists" deliberately pulling the rug from under their economies was recently reiterated by the Reserve Bank of India (RBI) governor Raghuram Rajan. In an interview with Bloomberg TV India Rajan said such rapid in-out financial flows “distort our economies". He accused the Fed of callous disregard, highlighting the break down of the international post crisis consensus championed by former UK prime minister Gordon Brown in 2009:
"International monetary co-operation has broken down. Industrial countries have to play a part in restoring that, and they cannot at this point wash their hands off and say ‘we will do what we need to, and you do the adjustment you need to’."
But some believe that Rajan protests too much. (I also said something along these lines in my India's wounds are largely self-inflicted blog last Autumn). Simon Johnson, former chief economist at the IMF and professor of entrepreneurship at MIT, accuses Rajan of using the Fed as a scapegoat for economic mismanagement by the Indian government. In an interview on BBC Radio 4’s Today show on Saturday, 1 February, Johnson suggested that Rajan was "constructing a smokescreen for domestic purposes". It is a view echoed to some extent by Eswar Prasad, another alumnus of the IMF who is now economics professor at Cornell University and author of The Dollar Trap.
In an op-ed in the Financial Times Prasad said that India expects far too much of the RBI, which he said is over-stretched as a result of having to both fight inflation and prop up the country's growth. Prasad argued that countries like India should look closer to home before lashing out at Yellen:
“Governments [...] should not pursue schizophrenic domestic policies and then expect central bankers across the world to sort out the mess."
Harvard University professor of economics Kenneth Rogoff points to other factors that are weakening emerging economies and strengthening developed ones. In a recent article for Project Syndicate, republished by Qfinance, Rogoff said the shale gas revolution in the US was have a dramatic effect on the global economic balance of power:
“Energy exporters such as Russia are feeling the downward pressure on export prices. At the same time, hyper-low-cost energy in the US is affecting Asian manufacturers’ competitiveness, at least for some products.”
Despite having been dubbed “Doctor Doom” for predicting the US subprime-induced financial meltdown in September 2006, Roubini seems optimistic about the emerging markets. He says a “full-fledged currency, sovereign-debt and banking crisis” remains highly unlikely, as the "Fragile Five" all benefit from flexible exchange rates, have reserves they can draw on in the event of runs on their currencies or banks, and fewer currency mismatches (such as, say, dependence on loans in foreign-currencies to finance investment in local-currency assets, a problem that beset much of Central and Eastern Europe in 2008-09).
Even though he said the short term policy trade-offs faced by their governments “remain ugly”, Roubini concluded his Project Syndicate piece by saying:
“Optimism about emerging markets is probably correct [...] 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, with one or two exceptions, the emerging markets are definitely better-placed to ride out the current storm than they were during the Asian and Russian crises of 1997-98. Templeton Emerging Markets Group's Mark Mobius is even more optimistic than Roubini, arguing that the rout in emerging market equities, which saw a basket of emerging market equities lose 3% of its value in January alone, is over. Personally I am not so sure; Mobius has EM funds to promote.
I would steer clear until we know how much further Roubini's "troubled ten" may have to fall.