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Are emergingmarketsgoingtocollapse? Whyis Dr. Doomwrong
The series of devaluations in the currencies of a few developing countries (I prefer the term to the one in the title, which became popular in the 1990s, when Neoliberal policies required selling bonds in international financial markets, and, hence, emerging markets sounded more marketable than underdeveloped country) has led to a lot of speculation about the collapse of the boom in the periphery. The graph below shows that depreciation has been between moderate to severe, depending on the country (source by TheEconomist).
The Argentine peso and the Turkish Lira lead the pack, by far. Nouriel Roubini, the so-called Dr. Doom, has suggested that the problems have a common cause, based political problems, and loose fiscal policy leading to external deficits. According to Roubini (here):
"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."
In all fairness the fragility of some of the countries is exaggerated, and the reasons are simply wrong. Yes it is true that current account deficits are in normal circumstances a very dangerous stance for developing countries that must borrow in foreign currency; however, the low rates of interest in the center, associated to a slow recovery from the crisis in the US and a terrible collapse in Europe, together with increasing international liquidity, implies that many countries have been able to finance their external imbalances.
The fiscal situation is also not pressing, and at any rate is only relevant to the extent that it affects the level of activity and imports. And as noted by Roubini, these countries are either not growing fast (like Brazil, which has primary surpluses) or decelerating (like India, where nominal deficits as a share of GDP have also decreased). Also, inflation is certainly NOT high in the majority of these countries (again Brazil and India do have single digit inflation levels,* even if the inflation rate is above the target, and that prompted central banks in both countries to hike interest rates).+
The expectations of tightening of US monetary policy, and the possible effects that this might have on developing countries has also been exaggerated. Again, according to Roubini:
"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."
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.
"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."
"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."
If you agree with Roubini, the solution would be contraction in all these peripheral countries. Devaluation and fiscal adjustment to ease the current account and fiscal imbalances, as the old (and I would argue the new) IMF used to demand.
However, it is hard to foresee a strong recovery in the US, and a steep, or even a mild, increase in interest rates by the Fed, now under Janet Yellen’s command. That obviously does not mean that capital flight might not take place in some countries, and that a few of them would actually face external crises. Yet, it seems unlikely that the situation in the center would completely reverse and lead to a generalized collapse of the peripheral countries. In fact, I would argue that a bigger risk would be a severe collapse in Europe, leading to a flight to safety (i.e. US dollar denominated bonds), even with very low rates in the US, and then a new round of external crises. That’s why regulation of capital flows is needed, as demanded by Kevin Gallagher (see here) and not austerity for the periphery, as Roubini wants.
* Also, there is no evidence that inflation around 6 or 7% is any worse than inflation at 4 or 5% in terms of growth or unemployment.
+ There are countries in which the story is more problematic. Argentina, discussed here and here, is certainly one, but interestingly enough it would be a case where the external accounts are actually not that bad.
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