The Strategist

Developing Countries are Slipping Lower

09/09/2015 - 14:50

Recent studies of the Institute of International Finance and the bank JPMorgan confirm that crisis hit emerging markets is in full swing

Rachel Strohm, on Flickr
Rachel Strohm, on Flickr
The stock markets of these countries slipped by 40%;

Government bonds of these countries are at risk because of significant individual debts.

Who remembers investors’ enthusiasm of at the bare mention of BRICS (Brazil, Russia, India, China, South Africa)? Who remembers the days when the seemingly endless growth in developing countries protected the global environment from the effects of diseases that covered the developed countries?

All of this is in the past. Russia not only has driven itself into political isolation, but, in economic terms, happened to be the country entirely dependent on the mere price of oil and incapable of real development. The admired Brazilian model, the combination of social support and smart market economy, has long reached the limits of growth. India gives hope yet, but still there is a long way to becoming a modern and economically developed nation. China made a bold attempt to shift from heavy reliance on exports to the path of sustained development, suddenly stumbled and pulled down the stock markets of developed countries.

However, problems have arisen not only in the former "stars". According to the Institute of International Finance, the crisis of the developing countries, without exception, is obliged to the deep, structural problems.

-    While fears, that the old, based on energy exports business model in emerging markets will collapse, are swelling, the growth in these regions, compared with developed countries, has slowed sharply, - says IIF director Hung Tran and his team. The experts have warned:

-    Even if the Federal Reserve postpones raising interest rates once again, it will help only in the short term.

Shares, traded on the emerging markets and compared to its highest value in April, collapsed in price by an average of 40% - much more than securities traded in developed markets. Those who reflects on the purchase, need a good think about the associated risks. BBH US bank assesses the prospects for the third quarter "with caution." According to its experts, the chances of Korea, Hong Kong, China, the United Arab Emirates and Taiwan are relatively good - unlike India, Egypt, South Africa, Russia and Brazil.

According to IIF analysis, weak stock exchanges of many developing countries had already been noted in 2011 due to the end of the "super cycle" of energy.

-    Basing on previous experience, such an increase in the energy sector usually lasts 15-20 years, the document says.

International Monetary Fund, in turn, warned of growing risks of slower growth in China, with low energy prices, a possibly overloaded balance of enterprises and financing problems due to capital outflows and currency fluctuations.

Opportunities to resist such developments, according to the IMF, are quite limited. Major oil-producing countries will take advantage of their financial and political capabilities, the rest are heavily dependent on exchange rate fluctuations, and therefore are subjected to more serious risks.

Even before the recent turmoil IIF warned that developing regions are suffering from a significant outflow of capital, including due to the imminent increase in interest rates by the Federal Reserve (in fact, the Central Bank of the United States), which promises to increase income from securities in the United States. Over the last four quarters, around 300 billion dollars belonging to individuals leaked away from these regions, which roughly corresponds to statistics of the 2008 crisis. The reduction of global trade, closely correlated with the situation in emerging markets, can be added to this as well.

IIF warned that government bonds of developing countries, still representing quite a profitable investment, soon would rapidly lose their value. Experts expect to reduce the solvency of enterprises for loans and warn that many companies, who took loans in foreign currency, have no insurance against major currency fluctuations.

The new forecast for JPMorgan, which is based on the data of the Bank for International Settlements, is composed in a similar tone. An analyst David Hensley indicates that the debts of private individuals in the developing regions in the past year reached 127% of GDP, and thus increased, compared with 2007, nearly by 50%. Mere bank loans account for 95% of GDP and thus overshadow the situation with government bonds. Debt increased mainly in Asian countries, with debts of companies much higher than household debt.

-    As interest grows, the situation is reminiscent of past financial crises in developing countries, says Hensley. Unlike previous years, the governments tend to have less debt, and the central banks, in some cases, have significant foreign exchange reserves. However, experts fear that some regions may reduce loans issued to companies. He cites Brazil as an example, where this trend has largely been manifested.

Debts of individuals are especially large regarding the performance of the economy at an annual rate in Hong Kong, where they make up 323% (an increase of 120 percentage points from 2007). Impressive are the corresponding figures in Malaysia (189%), Singapore (188%), Korea (169%) and China (152%). At the same time, these figures are only 60% in India, and in Turkey - 76%.

Meanwhile, the fact, that only 20% of GDP are debts to foreign countries, gives hope - thus risks associated with exchange rate fluctuations remain limited. Again, the foreign debts are large in Hong Kong and Singapore.

In general, despite the structural problems in developing countries, the financial crisis is not likely to be absolute. However, thence exchange differences suggest that these regions have lost their charm. It is also noteworthy that the times, when the developing countries were considered the main driving force of the world economy, fell in line with the times of continued growth of debt. Apparently, the economic miracle is not possible without this lever.

Original by Kathrin Witsch, Handelsblatt