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Difficult weeks ahead for the EMs

The bad start to 2014 for EMs shows that economic fundamentals still count and should be taken as a warning shot across the bows, writes Johan Krijgsman, of Krijgsman & Associates.

While developed economies have been bemoaning low rates of inflation at home, investors woke up to the very much higher, and not very well compensated, inflation rates in a number of key EM countries.

Triggered by less confidence in an ever-expanding China, the start of tapering in the US and bad weather turning minds to depressing thoughts, bringing capital back home became the strategy. How long this will last depends as much on EMs as it does on the developed country policy and economic environment.

In 1981, Antoine W van Agtmael coined the phrase “emerging markets”, to help rebrand Thailand for investors. Thirty-three years later, some have emerged more than others. A craft guild has grown up inventing acronyms (NICs, Bric, Mint, etc). It is helpful to differentiate emerging economies.

The fragile-five concept helps by pointing out the inflation and current-account problems, but it ignores the political ones, with which Thailand continues to find itself. I suggest NUTTS (Nigeria, Ukraine, Thailand, Turkey and South Africa) could help fill the gap.

Here besides questionable economics we have deflated investor expectations of how much progress has been and is likely to be made on governance and institutional reforms needed to accompany sustainable opportunities.

There is also the need to recognize the Least Likely to Emerge Markets (LLEM), populated by countries such as Argentina, Bolivia, Ecuador, Venezuela and a good chunk of Central America and the Caribbean.

For both NUTTS and LLEM, what is happening outside will not make as significant an impact until they get their acts sorted. Many of the remaining EMs (Chile, China, Mexico and Russia in particular) could be classed as Most Likely to Emerge Markets (MLEM).

Now in year six of low global interest rates and efforts to support the financial system, while reining in the 2008 blowout of budget deficits, developed countries are beginning to ask whether it is time for a policy change.

In the US, fiscal and external deficits have improved – repatriating armed forces and the energy boom should help this continue – and growth rates look likely to advance. Technology is replacing the need for off-shoring, the housing sector has bottomed and corporate balance sheets strengthened.

Tapering has begun and long-term interest rates are showing signs of edging upwards. As interest rates become more market-determined and less politically influenced, some volatility should be expected.

Few, however, believe that interest rates will rise to the extent that the consumer or the indebted in general will feel excruciating pain. This will allow a resuscitation of interest in some of the fragile five and the MLEM.

Elsewhere, Abenomics seems to be working in Japan, at least until the 3% VAT rise in April – with a possible additional 2% stultifying influence after that. Another caveat would be a smoothing of island-boundary disputes with China and Korea.

In the euro-area, while Germany and some immediate neighbours are progressing, most of the peripheral euro countries remain in a deep funk. For them it remains hard to imagine a successful outcome from the current euro strategy, given the requirement of years of paltry growth and high unemployment rates. Paying down debt by the non-euro EU also remains necessary – especially for former eastern bloc countries.

Overall, while there is a danger of being wrong-footed by policy changes, the outlook for macro demand this year on EMs is subdued, but positive. Particular challenges will remain. In addition to the civil-war-like noises from Ukraine and Thailand, politics will also be important in Turkey, South Africa and Nigeria. India and Brazil are gearing up to fight elections, but these should have less-momentous impacts.

A lessening of the ‘sugar daddy’ instinct by Venezuela will affect the LLEMs. Russia is trying to get the balance between the most cash for energy versus influence in its neighbourhood right as well. Countries stealing others’ lunches (Vietnam, Cambodia and Bangladesh) will continue, as will technology-assisted reshoring trends.

The US oil-supply boost will spill over on some countries – Algeria, Nigeria and Russia to a lesser extent – making high prices less secure.

Areas where the crystal ball is cloudy include the Middle East (US/Saudi relations, and the effects from the Arab Spring). The effect of reforms in China bear watching, and for success need to underplay credit growth and overplay the shift in propensities from investment towards consumption.

For some EMs, prospects are best contemplated while listening to Leonard Cohen’s song Everybody Knows (... the boat is leaking, everybody knows that the captain lied...).

Providing other EMs recall the old policy adages aiming for low inflation, subdued current-account deficits and real rates of return to investors, investor interest will return. Unlike previous crises, this latest one is not overwhelmed by extensive debt problems, at least not on the part of most of the EMs.

Johan Krijgsman is an independent economic consultant specializing in country risk and analysis of international economic and political developments. He is former head of the country and international analysis group at CIBC and director of Canoils, an evaluate energy company. Before returning to Canada, he studied in the UK and worked in South Africa (the Chamber of Commerce movement and Anglo American).

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