BRICS risk 'sudden stop' as dollar rally builds
By Ambrose Evans-Pritchard
9:01PM BST 22 May 2013
The stock of capital flowing into emerging markets has doubled from $4 trillion to $8 trillion since the Lehman Crisis, chasing a catch-up growth story that looks tired and has largely sputtered out in Brazil, Russia and South Africa.
Former IMF official Stephen Jen, now at SLJ Macro Partners, foresees a "sudden stop", the moment when funding for emerging markets dries up abruptly and investors run for the exits.
It is of "inferior quality", "fickle", and likely to be "fully reversed" as the Fed hoovers up excess money. The timing is in the hands of Bernanke, but the screws are already tightening for some in Asia, Latin America and the Mid-East as commodities deflate.
The cumulative inflow of capital has been 60pc of GDP in Lebanon, 58pc in Bulgaria, 56pc in Hungary, 50pc in Ukraine, 48pc in Poland, 42pc in Chile, 39pc in Romania, 32pc in Malaysia, 28pc in Thailand and 26pc in Turkey, to name a few. It can be good or bad. The devil is in the detail. But the overall level is what you see at cycle peaks. The IMF says the flows have been "ample but not alarming", yet also warned of a "sudden change in global market sentiment".
You can take a contrarian view, seeing the 12pc fall in the MSCI Index of emerging market stocks since early 2011 as a chance to pick up bargains. Bank of America says the sector "typically" beats the S&P 500 and Eurostoxx when the mood is this bearish. It depends whether you think the two-year drought is "typical", or the end of the road for a whole catch-up model.
South Africa has already become the first of the "BRICS" quintet to graduate from routine trouble to what looks like an old-fashioned Third World crisis. The current account deficit is 6pc of GDP. The rand plunged to a four-year low against the dollar this week, and 10-year bond yields have lost their footing.
“Clearly a risk that all of us see is a sudden change in sentiment. Once there have been good inflows there might be unanticipated outflows,”said finance minister Pravin Gordhan.
The fear is that South Africa is becoming ungovernable, with no end in sight to violent strikes by miners. Police opened fire on protesters at Lonmin's Marikana mine last year in a clash that killed 34 people.
Brazil has not yet lost its halo but it has all the signs of stagflation, and remains stuck where it has been for half a century in the "middle income trap". Manufacturing output is lower today than in 2008, more like Italy than China. It is the result of an over-mighty real during the iron ore and agro-boom, and a bad case of the "resource curse".
Fiscal policy was too loose, countered by tight money, so the real soared. Dilma Rousseff's government tried to blame others with talk of "currency war". Now it is dabbling in protectionism. We have seen this story before in Latin America.
Brazil's global ranking is 107 for infrastructure, 123 for roads, and 135 for ports, according to the World Economic Forum. The country never really overcame its bad habits. And much the same could be said of Russia, another resourse casualty that bet too heavily on oil and gas in the shale-shaken energy universe.
Russia is not in crisis. Growth is sputtering along at 1.6pc. Manufacturing is up 1.2pc over the past year. But the BRICS story is essentially dead, a "Bloody Ridiculous Investment Concept", says Mr Edwards.
It is true that India has embraced free markets - sort of - and ditched the suffocating Hindu Model. Yet the old India is still there, grappling with power blackouts, a current account deficit of 6.7pc of GDP and a central and local budget deficit near 10pc of GDP.
Stripped bare, the BRICS miracle is really about China, and even the Politburo has run into diminishing returns after ramping up credit from $9 trillion to $23 trillion in four years. At best China will have settle for more pedestrian growth, but it too is at the mercy of the Fed.
By pegging its currency to the dollar it risks an exchange rate surge against the rest of Asia, compounding the effects of a 30pc rise against Japan's yen since last summer.
This looks all too like the mid-1990s, when the yen crashed against the dollar and gave China a brutal deflationary shock. China's $3.4 trillion foreign reserves will prove no defence. To deploy reserves the would entail conversion back into yuan, causing the currency to rise. It would exacerbate the shock.
To cap it all, this is happening just as China's trade surplus vanishes and American firms switch plant back to US soil for cheaper power and better labour productivity. The wheel is turning full circle.
Local stock markets have already priced in the new reality.
Shanghai is off 70p from its 2008 peak in real terms. But foreigners who shovelled $8 trillion into their love affair with BRICS and bricklets have yet to adjust. European banks have lent $4.4 trillion to the bloc. Something to ponder.
These cycles of emerging market exuberance are as old as capitalism. They happened episodically all through the 20th Century, and all through 19th Century before that, usually ending with a cold douche. It should be no great shock if it happens yet again.