Roubini on Emerging Markets' Latest Problems

(February 3, 2014) — Emerging economies are likely to endure a bumpy ride for at least the next year, according to renowned economist Nouriel Roubini.

Writing on the Project Syndicate website, the man known as Dr Doom, for his prediction of the 2007/8 financial crisis, said recent trigger events including a currency crisis in Argentina, weaker economic data from China, and political uncertainty in Turkey, Ukraine, and Thailand, should not distract investors from those regions’ more profound problems.

“Many emerging markets are in real trouble,” he said. “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.”

Five other significant countries—Argentina, Venezuela, Ukraine, Hungary, and Thailand—are also vulnerable, according to Roubini. “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,” he said.

China faces risks from a demographic decline, slowing in GDP growth, and the potential fallout of a credit-fuelled investment boom, with excessive borrowing by local government, state-owned enterprises, and real-estate firms severely weakening banks’ and shadow banks’ asset portfolios, Roubini warned.

“Most credit bubbles this large have ended up causing a hard economic landing, and China’s economy is unlikely to escape unscathed, particularly as reforms to rebalance growth from high savings and fixed investment to private consumption are likely to be implemented too slowly, given the powerful interests aligned against them,” he said.

The economist stressed investors must remember these were not short-term problems. The risk of a hard landing in China posed a serious threat to emerging Asia, commodity exporters around the world—and even advanced economies, he said.

With the Fed’s tapering of its long-term asset purchases beginning in earnest and interest rates set to rise, 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.

“Another deep cause of current volatility is that the commodity super-cycle is over,” said Roubini. “This is not just because China is slowing; years of high prices have led to investment in new capacity and an increase in the supply of many commodities. Meanwhile, emerging-market commodity exporters failed to take advantage of the windfall and implement market-oriented structural reforms in the last decade; on the contrary, many of them embraced state capitalism, giving too large a role to state-owned enterprises and banks.”

These risks will not wane anytime soon, Dr Doom suggested. “Chinese growth is unlikely to accelerate and lift commodity prices; the Fed has increased the pace of its quantitative easing tapering; structural reforms are not likely until after elections; and incumbent governments have been similarly wary of the growth-depressing effects of tightening fiscal, monetary, and credit policies.

“Indeed, the failure of many emerging-market governments to tighten macroeconomic policy sufficiently has led to another round of currency depreciation, which risks feeding into higher inflation and jeopardising these countries’ ability to finance twin fiscal and external deficits.”

Despite these depressing predictions, Roubini was relatively unconcerned about the threat of a full-blown currency, sovereign-debt, or banking crisis. This is because all of the affected countries have flexible exchange rates, a large war chest of reserves to shield against a run on their currencies and banks, and fewer currency mismatches (such as when a country uses foreign-currency borrowing to finance investment in local-currency assets). Many also have sounder banking systems, while their public and private debt ratios, though rising, are still low, with little risk of insolvency.

Therefore, his long-term prediction for the asset class is one of optimism. Many medium-term fundamentals for most emerging markets, including urbanisation, industrialisation, catch-up growth from low per capita income, a demographic dividend, the emergence of a more stable middle class, the rise of a consumer society, and the opportunities for faster output gains once structural reforms are implemented, remain strong in his opinion.

Roubini concluded: “It is not fair to lump all emerging markets into one basket; differentiation is needed.

“But the short-run policy trade-offs that many of these countries face—damned if they tighten monetary and fiscal policy fast enough, and damned if they do not—remain ugly. The external risks and internal macroeconomic and structural vulnerabilities that they face will continue to cloud their immediate outlook. The next year or two will be a bumpy ride for many emerging markets, before more stable and market-oriented governments implement sounder policies.”

The full note can be found here.

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