Fate of the Fragile Five
D ESPITE THE massive wave of new issuance, 2013 was not a good year for the emerging world. Most of the indices were under water, as investors shifted their attention to the developed world.
The United States economy finally came back to life during the second semester.
The effects of sequestration, government shutdowns and political drama did little to derail the US recovery. Economic activity jumped 4.1 per cent y/y during the third quarter, after expanding 2.5 per cent y/y in the second quarter.
Exports, fixed investment and construction were strong, but the boost in output was mainly attributed to an accumulation of inventories. This caused concern among many investors, given that the initial retail data shows that the Christmas holidays were a bit lacklustre.
Nevertheless, the bump in economic activity confirmed the Federal Reserve’s decision to begin tapering its quantitative easing programme.
So far, the Fed has successfully engineered a shift in monetary policy without much disruption to global markets. Treasury yields are inching higher and emerging market bond prices are moving lower, but in an orderly manner.
The main question is how are the so- called Fragile Five – Brazil, India, Indonesia, Turkey and South Africa – going to fare?
Although they were once the darlings of the market, these five countries share a few troubling attributes. The first is large currentaccount deficits. The current account picture is improving in India, but the other countries have serious shortfalls.
EXPANSION IN CONSUMER DEBT
The second common problem is a dramatic expansion in consumer debt. All of the Fragile Five crowed about the large increases in their middle class, but the acceleration in social mobility was done through the appreciation of their currencies and the expansion of consumer credit.
Unfortunately, the boost in consumption was short- lived. These countries also boast some of the highest interest rates in the world. Therefore, it was only a matter of time until their consumers would collapse under a burden of debt.
The emphasis on consumption also shaped the type of investment that arrived in these countries, leading to more portfolio inflows rather than foreign direct investment.
The third common problem is rising consumer prices. The emphasis on consumption uncorked the inflation genie, leading to a real appreciation of their currencies and a loss of competitiveness.
Last of all, the Fragile Five share a great deal of political instability. In Turkey, the once unassailable Prime Minister Recep Tayyip Erdogan is on the ropes, under a deluge of corruption accusations. South Africa’s ANC is in danger of fragmenting after the death of Nelson Mandela. President Jacob Zuma cannot escape the constant barrage of criticism and scandals.
Indonesia and India are gearing up for elections next year. Indonesia will see a decade of SBY’s stewardship come to a close, and the BJP is looking like the sure winner in India.
Finally, Brazil had its fair share of riots in 2013, and the population is cringing at to what lies ahead with the World Cup. As a result of these common traits, the Fragile Five suffered a great deal of volatility in 2013, particularly as global portfolio managers shifted their focus to the developed markets.
But, what will happen to the rest of the emerging world? So far, there seems to be a marked differentiation between countries.
Countries with economic models that are more centred on the development of natural resources through the use of foreign direct
investment, such as Colombia, Peru and Chile, are doing well. Mexico is also poised to benefit from the acceleration of the US economy.
However, history tells us that the decoupling tends to be a short- term phenomenon in emerging markets. Therefore, these countries will eventually feel the effects of rising interest rates in the US and an improving economic outlook for the developed world.
Unfortunately, the change in the international economic environment coincides with a wave of presidential elections in Latin America. Brazil, Uruguay, Colombia and Panama will hold presidential elections in 2014.
Although the polls show that Brazilian President Dilma Rousseff should be re- elected, former Senator Marina Silva’s decision to leave the PT and join the Socialist Party ( PSB) may make the race more interesting. Silva is a well- regarded environmentalist and provides a new fresh face to the scandaltainted PT.
In Colombia, President Manuel Santos will most likely win the day, despite his low approval ratings. The opposition is badly divided and cannot assemble enough votes to block the incumbent.
The constitutions of Uruguay and Panama do not allow reelection. Therefore, the contests will be more heated.
As the emerging economies slow down, the electorate will surely move further to the left, thus heightening the sense of concern in the marketplace.
In sum, the outlook for this year is not as bright as it was in the recent past.