Emerging-market acronyms are misleading and unhelpful

Given the changes in the economic and political conditions, it is difficult to have labels that reflect appropriate categorisation at all times

PUBLISHED : Friday, 05 September, 2014, 1:19am
UPDATED : Friday, 05 September, 2014, 2:19am

No other global asset class has produced more labels and acronyms than emerging markets.

Ever since Goldman Sachs coined the term BRIC in 2001, referring to the world's large developing economies (Brazil, Russia, India and China), there has been a rapid succession of catchy investment concepts such as MIST, CIVETS and Next 11, which group smaller and less liquid emerging markets as well as some of the more exotic frontier markets.

The latest one, coined by Morgan Stanley during last summer's emerging-market sell-off triggered by plans by the United States Federal Reserve to wind down its programme of quantitative easing, is the "fragile five", which refers to countries suffering from balance of payment weaknesses - Brazil, Turkey, South Africa, Indonesia and India.

The Indian rupee and the Indonesian rupiah … [bely] their ‘fragile’ status

Yet while the appropriateness of the categorisation was already questionable at the end of last year - India's current account deficit stood at roughly 2 per cent of gross domestic product while Turkey's was close to 8 per cent and financed almost entirely by speculative inflows of foreign capital - it has lost much of its relevance this year.

The economic and political conditions among the "fragile five" have become much more diverse of late and defy easy categorisation.

On August 29, Brazil said the country had suffered a technical recession in the first half of this year, with the economy contracting 0.6 per cent in the second quarter, dragged down by a 5.3 per cent decline in investment.

The woes of Brazil contrast sharply with the renewed optimism about the prospects for India, whose economy posted its strongest growth rate in two years in the second quarter, expanding 5.7 per cent on an annualised basis.

Unlike Brazil's President Dilma Rousseff, who is disliked by financial markets because of her reluctance to undertake fiscal and structural reforms, the election in May of Narendra Modi as India's new premier is seen by investors as providing a crucial impetus to reform.

Markets are equally upbeat about Indonesia, particularly following the victory of the reform-minded Joko Widodo in July's presidential election. Indonesian equities have risen 28 per cent this year and 5.2 per cent in the past three months.

Even after depreciating against the resurgent US dollar this summer, the Indian rupee and the Indonesian rupiah are still up 4 per cent and 2 per cent, respectively, this year, belying their "fragile" status.

Turkey and South Africa, on the other hand, are the most deserving of the "fragile" label.

Turkish equities fell 3.5 per cent last month alone, while the lira, the country's currency, has lost 5 per cent against the dollar since mid-May.

Not only is Turkey's current account deficit still high at about 6.5 per cent of GDP, its central bank has lost inflation-fighting credibility, unlike its Indian and Indonesian counterparts, which have regained it.

Turkey's central bank has been cutting interest rates despite a surge in inflation to 9.3 per cent in July.

As for South Africa, whose economy has been flirting with recession and which is still reeling from a five-month mining strike that ended in June, stagflation has set in.

Its central bank is caught between a rock and a hard place. While it needs to raise interest rates, which are still negative in real terms, to curb inflation, tighter monetary policy will crimp growth further.

The current account deficit, although narrowing, is likely to stand at about 5 per cent of GDP by the end of this year - still too high, given the risks of a deterioration in sentiment towards emerging markets.

With equities in emerging markets up nearly 6 per cent over the past three months and continued inflows into their debt funds, market conditions remain favourable for the time being.

Yet the risks of an earlier-than-expected US interest rate rise, coupled with the fierce escalation in the East-West standoff over Ukraine, are weighing on sentiment and could trigger a sharper correction later this year.

As investment banks start thinking up new acronyms and labels for emerging markets, they should be mindful that these are invariably misleading, unhelpful and, as the case of the fragile five shows, often have a short shelf life.

Nicholas Spiro is managing director of Spiro Sovereign Strategy