Who said finance wasn’t fashionable? In this industry, we move through market trends and their associated acronyms almost as fast as Greek Finance Minister Varoufakis can come up with a controversial high fashion outfit. We focused exuberantly on the “BRICs” (Brazil, Russia, India, China) at the start of the decade, then in 2013 traded optimism for concern as we focused on the “Fragile Five” (Brazil, South Africa, India, Indonesia, Turkey), a group we believed doomed to collapse due to unsustainable funding costs in the face of rising US rates. 2014 brought a new set of challenges, and the BRICs, along with EM more broadly, have been re-contextualized in a lower growth, post commodity “supercycle” world. The “BRIC” components have been re-shuffled and regrouped, less optimistically, into the “CRaBs” (China, Russia, Brazil), a block comprising over 20% of global real GDP and considered by some as countries likely to weigh on global growth and sentiment. These are not the only countries under investor scrutiny-I’d also add Argentina, Venezuela, and Ukraine.
However, a look at country level spreads of EMBIG components reveals tremendous differentiation across the more challenged countries. While the aforementioned “CRaBs” may be vulnerable to slower growth, softer fundamentals, and political concerns, investors are not pricing anywhere near the amount of stress in these names as they are in Ukraine or Venezuela. What makes these challenged countries so differentiated? And, by comparison, how are some of those Fragile Five countries doing, and where else are we seeing opportunity?
The EM report card below addresses idiosyncratic factors influencing not only the struggling “CraBs”, and distressed names like Venezuela, but also strengthening names like Indonesia. Brazil, Russia, and Venezuela are certainly linked by vulnerability to a commodity selloff and by political strife, but key distinctions can be drawn between struggling and truly distressed names. Both Russia and Brazil are in recessionary growth territory and facing sticky inflation. Brazil is facing sluggish manufacturing, disappointing fiscal numbers and a growing current account (CA) deficit, and energy constraints as record droughts interfere with hydropower generation. In Russia, economic sanctions and geopolitical turmoil have certainly taken a toll on growth, trade and capital flows. For the foreseeable future, however, both countries appear to have the willingness and ability to avoid a solvency event. Though she’s met with significant resistance, Brazil’s re-elected President Rousseff is seeking to implement fiscal austerity after an extended period of tax breaks, easy credit and other measures used maintain popular political support. Though record lows in BRL and high inflation have created limited scope for monetary flexibility, market friendly Finance Minister Levy holds firm in his commitment to keep inflation under control, and stronger central bank credibility could leave room for an easing cycle to commence as early as next year. Russia has remained committed to fiscal discipline, and anti- crisis funding in the face of recession has added little new spending to the country’s budget.
By contrast, Venezuela has not exhibited the discipline or political will to emerge from a protracted economic tail spin. President Maduro lacks his predecessor’s charisma and ability to galvanize his constituents effectively. Stretched cash flows, plummeting oil prices, and dwindling reserves will challenge the political model, which relies heavily on using oil resources to provide subsidized goods to the populace and buy the support of Caribbean neighbors. With Maduro’s approval rating in the low 20s, the tenability of government institutions and the country’s ability to meet debt obligations are in serious question. Support is growing for an opposition victory in springtime general elections, but the reaction to this potential power shift away from the incumbent regime remains highly uncertain and potentially violent.
Though countries like Russia and Brazil are taking steps in the right direction, the effective implementation of such policies is by no means a certainty. Further, over the short to medium term, these adjustments will keep growth muted. However, the EM picture is not universally bleak. Countries like Indonesia and Hungary have committed to fostering growth domestically, and have been rewarded by the market. In Indonesia, new president Jokowi’s end to fuel subsidies will free up funds to be put to use for infrastructure and other key public projects. Similarly, Hungary has focused on programs designed to ease lending conditions for small businesses and help stimulate demand. Other factors supporting these countries include lower oil prices, as both countries are net importers, and the luxury of greater monetary policy flexibility. Further rate cuts are expected in Hungary, where inflation remains well below target, and in Indonesia, where inflation is expected to stabilize. These countries are certainly not without risks- Indonesia faces a persistent CA deficit, while external debt levels are high, though stabilizing, in Hungary. Nevertheless, it’s clear these countries are making positive strides to move to the top of the EM class by supporting endogenous growth and productive reforms.
EM Report Card
*Indicates a figure or projection sourced from J.P. Morgan
**Source: Economist, January 10, 2015