False hopes from an emerging markets rally
Rising equities do not remove the imperative for structural reforms
When even stocks in bedevilled Brazil enter a bull market, something is definitely going on. Following the turmoil in global financial markets at the turn of the year, the past two weeks have seen a sharp recovery in emerging economies’ assets.
The rally across a broad variety of emerging markets — the MSCI EM equity index is up about 15 per cent from its low in January — may have given some investors hope that the gloom hanging over the asset class is heavily overdone. But confidently inferring such an optimistic scenario from short-term market movements is generally an error, and so it is today.
Brazil is an excellent example of the problems facing many such nations. Having ridden the commodities boom from the early 2000s, and sailed relatively unscathed through the global financial crisis, the governments of Luiz Inácio Lula da Silva and Dilma Rousseff have manifestly failed to turn their windfall to good use.
Structural reform has essentially been abandoned, the economy has remained dangerously undiversified and public money has been wasted on prestigious but unproductive projects.
Brazil’s economy shrank 3.8 per cent last year, its worst performance for a quarter of a century.
Meanwhile, the quality of governance has declined considerably over the years. Once regarded as the bright hope of the emerging world, Mr Lula da Silva was detained by police on Friday as part of a fraud inquiry into Petrobras, the state oil company. And it is hardly a vote of investor confidence in Ms Rousseff when rumours of her imminent impeachment helped rather than hindered the stock market rally.
The markets have been here before on several occasions since emerging market growth started to slow in 2013. The “taper tantrum” on fears of the US Federal Reserve reducing the flow of cheap money was followed by a bout of turbulence in August over concerns about capital flight from China and downward pressure on the renminbi.
On each occasion, the panic has subsided but substantive worries have remained. China, which has yet to correct its vast stocks of debt and spare industrial capacity, faces a difficult transition without sparking a collapse in the renminbi that will be economically disastrous for other emerging markets.
Even with commodity prices recovering somewhat, oil producers across the world are having to cut spending and raise taxes to fill fiscal holes. Thanks to the lack of meaningful structural reform, estimated long-term sustainable growth rates are markedly lower now than before the crisis.
Emerging market policymakers would be foolish to take the recent market rally as evidence that they can slack off their efforts at macroeconomic stabilisation and microeconomic reform.
Market froth comes and goes, but the underlying currents of emerging market growth have been running too sluggishly for too long.