One of our most often used phrases with respect to emerging markets is that while they don’t suffer the same structural problems as many post-GFC developed economies they have plenty of their own to contend with. Events of the last few days, especially in some of the larger high current account deficit countries such as India, Indonesia and Brazil, are a recognition of those challenges as the US Federal Reserve looks to start tapering its asset purchase program.
is that Fed tapering means reduced global liquidity at a time when some
emerging market current account deficits have been deteriorating, admittedly
for some time, requiring greater capital inflows to fund them. It never ceases to amaze me how financial
markets tend to react to current account deterioration in some countries
including New Zealand; the deterioration is tolerated until, quite suddenly,
deterioration in current account balances has been significant. I have focussed on Indonesia, India and
Brazil given that in US dollar terms these deficits are amongst some of the
largest in the world.
I tend to
be more accepting of current account deficits in emerging markets. From an economic development perspective it
makes sense that developing countries should run current account deficits as
investment is front-loaded before incomes have risen sufficiently to generate a
pool of domestic savings. But that’s
only OK if what we are seeing is a gap between savings and investment rather
than excessive consumption. I am
actually more concerned with some emerging country budget deficits and the high
costs of domestic subsidies (for fuel for example) than I am about their current
account deficits. Of course getting
budget deficits under control improves national savings which will in turn
assist with the current account deficit.
digress. Some have likened the current
situation to a repeat of the 1997 Asian Financial Crisis (AFC). I disagree. For a start, exchange rate
regimes in Asia are typically more flexible now. Exchange rates have depreciated significantly
in recent months; the Indian Rupee is down 20% this year and the Indonesian
Rupiah is down 12%. Furthermore, banks
in Asia are in better shape than they were in 1997 and foreign exchange
reserves are much higher. In South
America, the Brazilian Real is down 12.5% this year.
external debt is lower now than it was in 1997.
Remember the Asian economies worked hard to improve their financial
positions following the AFC. Regular
readers will know I subscribe to the “saving glut” theory as the genesis of the
GFC. Strong export-led growth post the
AFC led to significant current account surpluses (i.e. emerging market savings)
which were “consumed” by the developed world with America acting as borrower of
last resort. Be careful what you wish
we are actually on the verge of an improvement in many emerging market current
account deficits. A number of factors
will contribute to this including the recent exchange rate depreciations which
will improve export competitiveness and will act as a constraint (depending on
elasticity of demand) on import growth.
the currency depreciation will be inflationary but that is likely to be
transitory. That said, we think it’s
still likely that Indonesia raises interest rates soon and while India has
raised some interest rates to support capital inflows, we think they will be
back to easing later this year on the back of weaker growth and relatively
contained underlying inflationary pressures.
In Brazil the central bank has been raising interest rates, the latest
move a 50bp hike this morning, but we think lower growth means inflation is
unlikely to reach the heights we expected just a few months ago which means
interest rate increases are nearly done.
also progressively lowered expected growth rates in India and Brazil this year.
We now see India growth at 5.6% this year with Brazil likely to come in at
around 2.0%. With respect to the current
account, weaker domestic demand means less import demand. Also remember that from global growth
perspective a relatively strong Japan and stabilisation in China and Europe are
providing some offset. In fact we look
for stronger growth in developed economies over the next few quarters to
support emerging market export growth.
don’t think the current situation is anywhere near as dire as it was in 1997.
Indeed we expect some improvement in emerging market current account deficits
over the next few months. However the
recent angst highlights that the need for growth enhancing structural reform is
not just a developed market phenomenon.
In the meantime, expect concern around key current account deficit
emerging economies to linger until some turnaround in their external positions