It’s that time of year again, when every sellside macro strategist peers into his or her crystal ball in a completely futile effort to predict the direction the global economy economy will take in the year ahead.
As everyone knows, the only thing more difficult than forecasting the weather is forecasting economic outcomes (economics is, after all, merely a pseudoscience and not one that the general public has much faith in at that), and as we’ve joked on several occasions, getting it wrong is almost part of the economist’s job description.
That said, some trends are undeniable and many times the best way to “get it right” (so to speak), is to look for broken stories. As Salient Partners’ Ben Hunt recently discussed in an interview with RealVisionTV, when the story is broken, you can bet the waters ahead will be choppy even if the longer-term outlook isn’t necessarily as dire. Well, if there’s any story that’s definitively broken right now, it’s EM.
As we’ve documented exhaustively, the emerging world is facing a perfect storm of collapsing commodities, depressed demand from China, the incipient threat of a Fed hike and thus an even stronger USD, the yuan deval, and acute idiosyncratic political crises (Brazil, Turkey, Malaysia). Heading into 2016, some might be wondering if it may be time to reevaluate the situation on the way to dipping a toe or two into EM in hopes of getting in at the bottom. With that in mind, we bring you the following excerpts from Citi on EM’s “broken growth model.”
First, there’s the notion that we have entered into a new era characterized by lackluster global trade that’s structural and endemic rather than cyclical and transitory. Throw in China’s deceleration and you’ve got a real problem:
Emerging economies’ growth prospects look damaged in several respects. The central fact facing EM is the negative external shock that results from weak global trade growth and the collapse of Chinese import growth. This brings to an irreversible end the period of rapid, investment-led Chinese growth and strong global trade growth which had supplied EM with a once-in-a-generation positive external shock during the years between 2002 and 2013.
And then there’s the idea that fiscal policy is hamstrung by a market that, in the wake of the EU debt crisis, is no longer tolerant of soaring debt-to-GDP ratios:
Fiscal policy is tight across EM because private capital markets seem quite intolerant of rising public debt levels in EM (note Brazil’s fate). Even in countries that are actively trying to loosen fiscal policy — Indonesia, or Korea, for example — the loosening is quite modest.
Additionally - and we’ve seen this in Brazil [11] - the private sector is already overleveraged, meaning the credit impulse is likely to be subdued. Also - and China is a good example here - banks may be reluctant to lend in an environment where borrowers are clearly over-extended and can’t, in some instances, service their existing debt.
In addition, domestic credit conditions remain tight in many countries across EM, because many countries already have had a domestic ‘credit boom’, and this means that risk appetite is low in domestic credit markets across EM.
So, all the three main sources of GDP growth — exports, public and private domestic spending — are constrained. The persistence of this problem has led us, alongside many other forecasters, to underestimate the EM slowdown consistently over the past four years (Figure 1).
[12]
And “plenty of financial vulnerabilities remain:”
One important difference between this crisis and previous ones in the 1980s and 1990s is that EM crises in the past were more or less entirely located in the balance of payments, while this crisis has more diverse roots: it is as much about a crisis of growth as it is about weakness in the balance of payments. But it is true that there are important balance of payments fragilities in EM. Some countries (eg South Africa) have stubborn current account deficits, and a number of countries – Brazil, Russia, Turkey, China, India, Indonesia – saw their corporate fx indebtedness rise sharply in recent years.
Finally, no one is “out of the woods” despite how “cheap” EM FX has become:
This is because of two remaining threats. One is the consequences of “Fed lift-off”; and the other from China. Higher US rates do still threaten capital flows to EM, largely because some of the ‘excess’ inflow to EM in the past five years will have had cyclical characteristics, and could therefore be vulnerable as US rates rise.
[13]
The bottom line is that when you look out across the space, it's not just that the growth model is, as Citi puts it, "broken." You also need to consider the fact that three of the world's most important emerging markets are on the verge of an outright collapse.
There's Brazil, which is stuck in a stagflationary nightmare exacerbated by an intractable political crisis that may well end up plunging the country into a depression (see Q3 GDP data [14] out on Tuesday).
There's also Turkey, where a maniacal leader hell bent on consolidating absolute power in the Presidency has plunged the country into civil war and now seems prepared to push NATO into an armed conflict with Russia.
And of course there's China, were decelerating growth, an unstable equity market, persistent capital flight, and a looming private sector debt crisis threaten to destabilize the world's engine of growth.
Set all of that against a backdrop of depressed global trade and still lackluster demand, and one by one, we could see the world's "emerging" economies backslide into "frontier" status.
