The contrarian case for emerging markets

It is not that emerging markets are cheap, but they are not dear

TWENTY years ago, on August 17th 1998, the Russian government devalued the rouble, defaulted on its domestic debts and suspended all payments to foreign creditors. It was one of the most dramatic days of a year-long emerging-market crisis that began with the devaluation of the Thai baht. South Korea and Malaysia would suffer brutal recessions. President Suharto of Indonesia was forced to resign after 32 years that May. But it was Russia’s default that shook the world.

Talk of rich-world recession was soon in the air. The Federal Reserve would cut interest rates three times before the year was out. The MSCI index of emerging-market stocks, which had lost 40% of its dollar value in the year leading up to August 1998, dropped by more than a quarter in that month alone.

Emerging-market assets are not as scorned now as they were then. The panic resulting from Turkey’s crisis is not anything like as acute. But there is no shortage of reasons for investors to be wary.

Unloved asset classes have at least one charm—they tend to sell at a discount. The price you pay for a stream of company earnings in emerging markets is lower than in the rich world—and far lower than in America. After a Turkey-inspired sell-off in the foreign-exchange market, currencies look fairly valued. A lot of fund managers would be putting their careers at risk by buying assets that have just fallen a lot. But those with longer horizons may find it worthwhile to take a look.

It is not so much that emerging markets are cheap, but that they are not dear. The price-to-earnings, or PE, ratio for the dollar index of emerging-market stocks is 14, a bit below its average since 1996. It looks even better value when you compare its PE ratio to that of the S&P 500 index of American stocks over time. At the start of 1996, both had PE ratios of around 18. Whenever the S&P 500’s valuation has since risen relative to that of emerging-market stocks, it has eventually fallen back again (see chart). America’s stockmarket currently has a PE of 23. It has been even dearer relative to emerging-market stocks in the past—but only rarely.

Sound FX

There other factors to consider. Currency risk is one. In rich countries, stocks and currencies sometimes move in offsetting directions. When the pound slumped after the Brexit vote in June 2016, it prompted a rally in British stocks, as companies’ foreign earnings became more valuable in sterling terms. Emerging markets are different. The prices of shares and currencies tend to rise and fall in tandem.

Buying cheap stocks is no good if the currencies they are denominated in are overvalued. But is not obvious that they are. Even before the recent selling, real exchange rates in most big emerging markets were below their ten-year averages. A bout of high inflation would upset that reckoning. Currencies might then need to fall to keep the real exchange rate steady and exports competitive. That is not a big risk. Of the 25 emerging markets listed on the indicator pages of The Economist, only three (Turkey, Argentina and Egypt) have inflation rates above 6%. Most are below 3%.

It is unsurprising, then, that emerging markets are favoured by “value” investors. This austere band prefers stocks with a low PE or a low price relative to the book value of assets. GMO, a fund-management group with an almost fanatical devotion to value, has a heavy weighting of emerging-market shares in its discretionary portfolio (and no American equities).

For many tastes, the value approach is a bit too virtuous, a little too much like a diet of steamed vegetables. There is no law that says cheap stocks cannot become cheaper. Turkey may be an outlier in terms of its erratic policymaking and the scale of its foreign debts, but its agonies seem likely to be protracted. Troubles elsewhere are a drain on confidence. Russia is another target of US sanctions. Mexico has NAFTA negotiations hanging over it. Elections in Brazil are likely to be fractious. China’s economy is slowing. The valuation gap with America may already be stretched. But it could still widen.

It would be nice if it were easy to judge when to lighten up on dear stocks and load up on cheaper ones. People who can do this reliably are rare. For everyone else, valuation must come into the reckoning. Betting on emerging markets at this juncture would be gutsy. But sometimes the time to buy is when others are scared. There was plenty to fear 20 years ago. The emerging-market crisis had rattled much of Asia and would soon roil Brazil and Argentina.

Even so, emerging-market stocks reached a low in dollar terms a few weeks after the Russian default. Within 18 months they had doubled.

Trump Administration Discussed Coup Plans With Rebel Venezuelan Officers

By Ernesto Londoño and Nicholas Casey

A military ceremony in Caracas, Venezuela, this month. The White House declined to answer detailed questions about talks with rebellious officers.CreditCreditJuan Barreto/Agence France-Presse — Getty Images

The Trump administration held secret meetings with rebellious military officers from Venezuela over the last year to discuss their plans to overthrow President Nicolás Maduro, according to American officials and a former Venezuelan military commander who participated in the talks.

Establishing a clandestine channel with coup plotters in Venezuela was a big gamble for Washington, given its long history of covert intervention across Latin America. Many in the region still deeply resent the United States for backing previous rebellions, coups and plots in countries like Cuba, Nicaragua, Brazil and Chile, and for turning a blind eye to the abuses military regimes committed during the Cold War.

The White House, which declined to answer detailed questions about the talks, said in a statement that it was important to engage in “dialogue with all Venezuelans who demonstrate a desire for democracy” in order to “bring positive change to a country that has suffered so much under Maduro.”

But one of the Venezuelan military commanders involved in the secret talks was hardly an ideal figure to help restore democracy: He is on the American government’s own sanctions list of corrupt officials in Venezuela.

He and other members of the Venezuelan security apparatus have been accused by Washington of a wide range of serious crimes, including torturing critics, jailing hundreds of political prisoners, wounding thousands of civilians, trafficking drugs and collaborating with the Revolutionary Armed Forces of Colombia, or FARC, which is considered a terrorist organization by the United States.

American officials eventually decided not to help the plotters, and the coup plans stalled. But the Trump administration’s willingness to meet several times with mutinous officers intent on toppling a president in the hemisphere could backfire politically.

Most Latin American leaders agree that Venezuela’s president, Mr. Maduro, is an increasingly authoritarian ruler who has effectively ruined his country’s economy, leading to extreme shortages of food and medicine. The collapse has set off an exodus of desperate Venezuelans who are spilling over borders, overwhelming their neighbors.

Even so, Mr. Maduro has long justified his grip on Venezuela by claiming that Washington imperialists are actively trying to depose him, and the secret talks could provide him with ammunition to chip away at the region’s nearly united stance against him.

“This is going to land like a bomb” in the region, said Mari Carmen Aponte, who served as the top diplomat overseeing Latin American affairs in the final months of the Obama administration.

Mr. Maduro at a meeting with ministers in Caracas this month. Most Latin American leaders agree that he is an increasingly authoritarian ruler who has effectively ruined his country’s economy.CreditMiraflores Palace

Beyond the coup plot, Mr. Maduro’s government has already fended off several small-scale attacks, including salvos from a helicopter last year and exploding drones as he gave a speech in August. The attacks have added to the sense that the president is vulnerable.

Venezuelan military officials sought direct access to the American government during Barack Obama’s presidency, only to be rebuffed, officials said.

Then in August of last year, President Trump declared that the United States had a “military option” for Venezuela — a declaration that drew condemnation from American allies in the region but encouraged rebellious Venezuelan military officers to reach out to Washington once again.

“It was the commander in chief saying this now,” the former Venezuelan commander on the sanctions list said in an interview, speaking on condition of anonymity out of fear of reprisals by the Venezuelan government. “I’m not going to doubt it when this was the messenger.”

In a series of covert meetings abroad, which began last fall and continued this year, the military officers told the American government that they represented a few hundred members of the armed forces who had soured on Mr. Maduro’s authoritarianism.

The officers asked the United States to supply them with encrypted radios, citing the need to communicate securely, as they developed a plan to install a transitional government to run the country until elections could be held.

American officials did not provide material support, and the plans unraveled after a recent crackdown that led to the arrest of dozens of the plotters.

Relations between the United States and Venezuela have been strained for years. The two have not exchanged ambassadors since 2010. After Mr. Trump took office, his administration increased sanctions against top Venezuelan officials, including Mr. Maduro himself, his vice president and other top officials in the government.

The account of the clandestine meetings and the policy debates preceding them is drawn from interviews with 11 current and former American officials, as well as the former Venezuelan commander. He said at least three distinct groups within the Venezuelan military had been plotting against the Maduro government.

One established contact with the American government by approaching the United States Embassy in a European capital. When this was reported back to Washington, officials at the White House were intrigued but apprehensive. They worried that the meeting request could be a ploy to surreptitiously record an American official appearing to conspire against the Venezuelan government, officials said.

Venezuelans waiting to buy government-subsidized food in Caracas in May. The country is experiencing extreme shortages of food and medicine.CreditMeridith Kohut for The New York Times

But as the humanitarian crisis in Venezuela worsened last year, American officials felt that having a clearer picture of the plans and the men who aspired to oust Mr. Maduro was worth the risk.

“After a lot of discussion, we agreed we should listen to what they had to say,” said a senior administration official who was not authorized to speak about the secret talks.

The administration initially considered dispatching Juan Cruz, a veteran Central Intelligence Agency official who recently stepped down as the White House’s top Latin America policymaker. But White House lawyers said it would be more prudent to send a career diplomat instead.

The American envoy was instructed to attend the meetings “purely on listening mode,” and was not authorized to negotiate anything of substance on the spot, according to the senior administration official.

After the first meeting, which took place in the fall of 2017, the diplomat reported that the Venezuelans didn’t appear to have a detailed plan and had showed up at the encounter hoping the Americans would offer guidance or ideas, officials said.

The former Venezuelan commander said that the rebellious officers never asked for an American military intervention. “I never agreed, nor did they propose, to do a joint operation,” he said.

He claimed that he and his comrades considered striking last summer, when the government suspended the powers of the legislature and installed a new national assembly loyal to Mr. Maduro. But he said they aborted the plan, fearing it would lead to bloodshed.

They later planned to take power in March, the former officer said, but that plan leaked. Finally, the dissidents looked to the May 20 election, during which Mr. Maduro was re-elected, as a new target date. But again, word got out and the plotters held their fire.

It is unclear how many of these details the coup planners shared with the Americans. But there is no indication that Mr. Maduro knew the mutinous officers were talking to the Americans at all.

For any of the plots to have worked, the former commander said, he and his comrades believed they needed to detain Mr. Maduro and other top government figures simultaneously. To do that, he added, the rebel officers needed a way to communicate securely. They made their request during their second meeting with the American diplomat, which took place last year.

Lawmakers in Caracas last month. The plotters considered striking last summer, when the government suspended the powers of the legislature and installed a new assembly loyal to Mr. Maduro.CreditCristian Hernandez/EPA, via Shutterstock

The American diplomat relayed the request to Washington, where senior officials turned it down, American officials said.

“We were frustrated,” said the former Venezuelan commander. “There was a lack of follow-through. They left me waiting.”

The American diplomat then met the coup plotters a third time early this year, but the discussions did not result in a promise of material aid or even a clear signal that Washington endorsed the rebels’ plans, according to the Venezuelan commander and several American officials.

Still, the Venezuelan plotters could view the meetings as tacit approval of their plans, argued Peter Kornbluh, a historian at the National Security Archive at George Washington University.

“The United States always has an interest in gathering intelligence on potential changes of leadership in governments,” Mr. Kornbluh said. “But the mere presence of a U.S. official at such a meeting would likely be perceived as encouragement.”

In its statement, the White House called the situation in Venezuela “a threat to regional security and democracy” and said that the Trump administration would continue to strengthen a coalition of “like-minded, and right-minded, partners from Europe to Asia to the Americas to pressure the Maduro regime to restore democracy in Venezuela.”

American officials have openly discussed the possibility that Venezuela’s military could take action.

On Feb. 1, Rex W. Tillerson, who was secretary of state at the time, delivered a speech in which he said the United States had not “advocated for regime change or removal of President Maduro.” Yet, responding to a question afterward, Mr. Tillerson raised the potential for a military coup.

“When things are so bad that the military leadership realizes that it just can’t serve the citizens anymore, they will manage a peaceful transition,” he said.

Days later, Senator Marco Rubio of Florida, who has sought to shape the Trump administration’s approach toward Latin America, wrote a series of Twitter posts that encouraged dissident members of the Venezuelan armed forces to topple their commander in chief.

Venezuelans waiting to register with the Brazilian immigration authorities in April. The economic collapse has set off an exodus of desperate Venezuelans.CreditMeridith Kohut for The New York Times

“Soldiers eat out of garbage cans & their families go hungry in Venezuela while Maduro & friends live like kings & block humanitarian aid,” Mr. Rubio wrote. He then added: “The world would support the Armed Forces in #Venezuela if they decide to protect the people & restore democracy by removing a dictator.”

In a speech in April, when he was still White House policy chief for Latin America, Mr. Cruz issued a message to the Venezuelan military. Referring to Mr. Maduro as a “madman,” Mr. Cruz said all Venezuelans should “urge the military to respect the oath they took to perform their functions. Honor your oath.”

As the crisis in Venezuela worsened in recent years, American officials debated the pros and cons of opening lines of dialogue with rebellious factions of the military.

“There were differences of opinion,” said Ms. Aponte, the former top Latin America diplomat under Mr. Obama. “There were people who had a lot of faith in the idea that they could bring about stability, help distribute food, work on practical stuff.”

But others — including Ms. Aponte — saw considerable risk in building bridges with leaders of a military that, in Washington’s assessment, has become a pillar of the cocaine trade and human rights abuses.

Roberta Jacobson, a former ambassador to Mexico who preceded Ms. Aponte as the top State Department official for Latin America policy, said that while Washington has long regarded the Venezuelan military as “widely corrupt, deeply involved in narcotics trafficking and very unsavory,” she saw merit in establishing a back channel with some of them.

“Given the broader breakdown in institutions in Venezuela, there was a feeling that — while they were not necessarily the answer — any kind of democratic resolution would have had to have the military on board,” said Ms. Jacobson, who retired from the State Department this year. “The idea of hearing from actors in those places, no matter how unsavory they may be, is integral to diplomacy.”

But whatever the rationale, holding discussions with coup plotters could set off alarms in a region with a list of infamous interventions: the Central Intelligence Agency’s failed Bay of Pigs invasion to overthrow Fidel Castro as leader of Cuba in 1961; the American-supported coup in Chile in 1973, which led to the long military dictatorship of Augusto Pinochet; and the Reagan administration’s covert support of right-wing rebels known as the contras in Nicaragua in the 1980s.

In Venezuela, a coup in 2002 briefly deposed Mr. Maduro’s predecessor, Hugo Chávez. The United States knew a plot was being hatched but warned against it, according to a classified document that was later made public. The coup took place anyway and the George W. Bush administration opened a channel to the new leader. Officials then backed away from the new government after popular anger rose against the coup and countries in the region loudly denounced it. Mr. Chávez was reinstated as president.

In the latest coup plot, the number of military figures connected to the plan dwindled from a high of about 300 to 400 last year to about half that after a crackdown this year by Mr. Maduro’s government.

The former Venezuelan military officer worries that the 150 or so comrades who have been detained are probably being tortured. He lamented that the United States did not supply the mutineers with radios, which he believes could have changed the country’s history.

“I’m disappointed,” he said. “But I’m the least affected. I’m not a prisoner.”

Failing conventionally

Why Argentine orthodoxy has worked no better than Turkish iconoclasm

Both countries’ currencies have plunged. Only one is taking the prescribed medicine

WHEN an emerging market loses favour with its creditors, how should its government respond? The policy prescriptions do not typically include intimidating the central bank, railing against the “interest-rate lobby”, falling out with allies, eschewing the IMF’s help, pouring scorn on the dollar or appointing the president’s son-in-law as finance minister. Turkey has done all of these things, and its currency has duly lost 40% of its value this year.

Argentina, by contrast, has stuck much closer to convention. Its finance minister has two economics-related degrees. Its central bank has raised interest rates through the roof (lifting them to 60% on August 30th), and its government has secured prompt and generous assistance from the IMF, which agreed to a $50bn loan in June, the largest in its history. And yet Argentina’s currency has lost over 50% of its value this year (see chart 1).

Why has Argentine orthodoxy yielded such poor results? The question is growing more urgent. America’s monetary tightening, and worries about President Donald Trump’s trade wars, mean many emerging markets are looking wobbly. On September 3rd Argentina’s government said it would tighten the ship still further, slashing the number of ministries from 19 to ten, raising export taxes and cutting subsidies on transport and utilities. It now aims to balance the budget (before interest payments) in 2019—an election year. It also plans to muster a budget surplus of 1% of GDP in 2020. That will require a fiscal turnaround matched by only the toughest 15% of IMF programmes, according to Sergi Lanau of the Institute of International Finance (IIF), a bankers’ think-tank. Is Argentina wrong to persist with such toughness? Should Mauricio Macri, its president, perhaps appoint one of his children as finance minister instead?

The answer, of course, is no. The peso’s underperformance is not, for the most part, an indictment of conventional economics. It instead reflects three other factors: idiosyncratic misfortunes; the structural differences between Argentina’s economy and Turkey’s more trade- and credit-intensive growth model; and the awful starting position that Mr Macri inherited from his predecessors, Cristina Fernández de Kirchner and her late husband, Néstor Kirchner, who indulged in years of mismanagement that would appal even Turkey’s iconoclastic government.

Start with the idiosyncrasies. Argentina’s worst drought in 50 years has damaged farm output and dried up an important source of hard currency. That bad luck has been accompanied by several eminently avoidable blunders. In a short video posted on YouTube on August 29th, Mr Macri attempted to quash any doubts over Argentina’s solvency by announcing that the IMF had agreed to hasten the disbursal of its loan, only $15bn of which was paid out upfront. But this claim was followed by neither clarification from the finance ministry nor confirmation from the IMF. Panic and confusion spread. The next day—soon dubbed “Black Thursday” by Argentines—the peso fell by almost a fifth.

That miscommunication may reflect a deeper failure of co-ordination. Whereas investors in Turkey worry that power is too concentrated in the hands of its president, Recep Tayyip Erdogan, investors in Argentina worry that economic authority has been dispersed too widely. The government entered the crisis with a finance minister and treasury minister whose remits intertwined, both of whom had to contend with a powerful cabinet chief. Investors did not know who was in charge.

Many still believe that Nicolás Dujovne, the finance minister, should be given a stronger mandate to set economic policy. “If you are a country at war you don’t send in one division at a time to fight,” says Marcos Buscaglia of Alberdi Partners, an economic consultancy. “You need to send them all in at once.” He reckons the government needs to secure a joint agreement with provincial governors to cut spending together. “The provinces are where the biggest waste lies,” he says.

The peso’s plunge also reflects deeper differences between Argentina’s economic structure and Turkey’s. International trade, for example, plays a far bigger role in the Eurasian country, which belongs to a customs union with the European Union. Trade is equivalent to 54% of the country’s GDP, compared with only 25% of Argentina’s (see chart 2). A city like Istanbul generates foreign exchange from both antiquity and novelty. The Byzantine and Ottoman architecture in its city centre attracts droves of tourists, and the nimble textile firms on its outskirts serve fast-fashion retailers on Europe’s high streets.

Turkey does not therefore need as big a devaluation for the same improvement in its trade balance. According to the IIF’s estimates, the combination of the economic slowdown and the lira’s fall is already enough to turn its current-account deficit of 6% of GDP into a surplus in due course. The greater fall in Argentina’s currency has merely narrowed its underlying current-account deficit, from about 5% of GDP to 3%, according to the IIF’s calculations.

Turkey’s economy also boasts greater financial depth than Argentina’s. Loans to the private sector (excluding lending between financial institutions) amounted to 85% of GDP at the end of 2017, according to the Bank for International Settlements. The figure for Argentina was under 22%. Thus Argentina needs a larger increase in borrowing costs for the same slowdown in growth, notes Charlie Robertson of Renaissance Capital, an investment bank.

Argentina’s debts, especially its dollar liabilities, mostly lie with the government; Turkey’s sit with firms. And though Turkey’s central bank has been slow to raise the official cost of borrowing for banks, those commercial lenders have been quick to raise interest rates for their decreasingly creditworthy borrowers. Banks now charge even big companies around 35%, according to a local economist.

When credit tightens, companies must cut back. Unlike governments, they cannot, and need not, wait for political approval to do so. As a consequence, Turkey’s private-sector austerity has been more swift and savage than Argentina’s public-sector version. The economy is already slowing sharply. Only half as many cars were sold last month as a year before, the distributors’ association said on September 4th.

Battered on the Bosphorus

Foreign investors may have become fixated on the shared vulnerabilities of Turkey and Argentina: high inflation, large foreign-currency debts, troublesome budget deficits and wide current-account gaps. But the underlying differences between the two economies are equally stark.

Mr Macri, who won office at the end of 2015, inherited a warped economy, in greater disrepair than Turkey’s is in even today. A dispute with holders of its defaulted debt had left Argentina’s government cut off from international credit markets. Currency controls meant the peso was artificially expensive and export taxes prompted producers to hoard grain.

If Argentina’s public debt remained modest, it was only because the government financed itself with freshly created money from the central bank. If inflation appeared manageable, it was only because the government fiddled the figures and capped prices. And if the trade balance looked favourable, it was only because the government banned many imports and rationed access to foreign exchange.

As these distortions were removed, Argentina’s problems became manifest. It faced high and stubborn inflation, perpetuated by many wage settlements tightly linked to past increases in the cost of living. It inherited an underlying fiscal imbalance that had to be financed by increased debt, if it were not to be financed by the central bank. And it was saddled with a sharply overvalued currency. According to Renaissance Capital, even after its recent plunge Argentina’s peso is only 25% below “fair value” (based on long-term, inflation-adjusted averages). The Turkish lira, by contrast, is already 44% undervalued.

Much of the blame for Argentina’s plight lies, then, not with the government’s conventional response to the crisis, but with its unconventional predecessor. Mr Macri’s application of orthodoxy has, however, proved to be counterproductive in three, indirect ways.

First, his reformist image helped attract copious capital flows from abroad, culminating in the sale of a 100-year bond in June 2017. That initial enthusiasm for its debt then lulled the government into complacency, convincing it to cut the fiscal deficit more gradually than originally planned. On September 3rd Mr Macri confessed that the government’s gradualism had been born of “excessive optimism”.

Second, in repairing the economy, the government also, on occasion, embraced microeconomic orthodoxy at the expense of macroeconomic stability. It lifted taxes on exports, which removed a clumsy distortion but also deprived it of much-needed revenue. It reduced fuel subsidies, which brought prices into closer alignment with costs but also contributed to inflation, especially as the subsidy reductions were coupled with tax cuts to ease the pain.

The incredibles

Lastly, Argentina’s policymakers made several highly orthodox commitments they proved unable to keep. The central bank adopted ambitious inflation targets it subsequently had to relax. After the IMF agreement, it promised to leave the peso to market forces, stepping into the currency markets only in extremis. Despite this pledge, it has repeatedly intervened, presumably because Argentina has rarely been out of extremis ever since.

The central bank’s decision on Black Thursday to raise interest rates by 15 percentage points also seems like an over-reaction. Instead of appearing resolute, the central bank seemed rattled.

No central bank can credibly promise to destroy the economy to save the currency.

Turkey’s approach has hardly served its economy well. Its finance minister, Berat Albayrak, is now also preaching the need for tighter fiscal policy. After inflation rose to nearly 18% last month, its central bank heavily hinted that it will raise interest rates at its meeting on September 13th.

Argentina, meanwhile, having already tried the Kirchners’ brand of populism, and Mr Macri’s earlier form of gradualism, has little alternative but to persist with its orthodox approach. Its miscommunications, however, are an object lesson on the dangers of overpromising. As a vulnerable emerging market, it should strive to be as economically sound as possible. But not more so.

Can Turkey Rewrite the Crisis-Management Rules?

Mohamed A. El-Erian

LAGUNA BEACH – Whether by accident or design, Turkey is trying to rewrite the chapter on crisis management in the emerging-market playbook. Rather than opting for interest-rate hikes and an external funding anchor to support domestic policy adjustments, the government has adopted a mix of less direct and more partial measures – and this at a time when Turkey is in the midst of an escalating tariff tit-for-tat with the United States, as well as operating in a more fluid global economy. How all this plays out is important not only for Turkey, but also for other emerging economies that already have had to cope with waves of financial contagion.

The initial phases of Turkey’s crisis were a replay of past emerging-market currency crises. A mix of domestic and external events – an over-stretched credit-led growth strategy; concerns about the central bank’s policy autonomy and effectiveness; and a less hospitable global liquidity environment, owing in part to rising US interest rates – destabilized the foreign-exchange market.

A political spat with the US accelerated the run on the Turkish lira by fueling a self-reinforcing dynamic. And all of this occurred in the context of a more uncertain and – aside from the US – weakening global economy.

In keeping with the traditional emerging-market-crisis script, Turkey’s currency crisis spilled over onto other emerging economies. As is typically the case, the first wave of contagion was technical in nature, driven mainly by generalized outflows from Turkey’s currency and bond markets. The longer this contagion continues, the greater the concern that it will lead to more disruptive financial and economic outcomes. As such, central banks in several emerging economies – as diverse as Argentina, Hong Kong, and Indonesia – felt compelled to take counter-measures.

What has followed is what makes this episode of emerging-market crisis different, at least so far. Rather than sticking with the approach taken by numerous other countries – including Argentina earlier this year – by raising interest rates and seeking some form of support from the International Monetary Fund, Turkey has shunned both in a very public manner, including through strident remarks by President Recep Tayyip Erdoğan.

Facing an accelerated exchange-rate depreciation that, at one stage, almost halved the lira’s value, Turkey has taken a variety of measures that attempt to simulate – albeit partially – the traditional approach that emerging economies have tended to follow in the past.

Domestically, it tightened funding conditions and, at the same time, provided liquidity to domestic banks, along with regulatory forbearance. It made it harder for foreigners to access lira liquidity, thereby squeezing speculators that had shorted the currency. It promised to deal with credit and fiscal excesses while ruling out capital controls. Externally, the government has mobilized at least $15 billion from Qatar to be used for direct investment in Turkey. And, in the midst of all this, the government also found time to retaliate against the doubling of tariffs on Turkish metal exports by US President Donald Trump’s administration.

The question is whether this response will be enough to act as a circuit breaker, thus giving the Turkish economy and its financial system time to regain their footing. This is particularly important because continued currency turmoil would tip the economy into recession, raise inflation, stress the banking system, and increase corporate bankruptcies.

With this comes the toughest question of all for the government: Can it bring about recovery without reneging on its pledge not to raise interest rates or approach the IMF? It is possible, but not probable.

Absent additional measures, it is unlikely that a critical mass of corrective steps has been attained in Turkey. While the domestic policy adjustments provide short-term relief for the currency, they may be neither comprehensive nor sufficient as yet to return Turkey to a promising path for inclusive economic growth and durable financial stability.

On the external side, the funding from Qatar, assuming it materializes fully and in a timely fashion, appears small relative to Turkey’s gross external funding needs. It also doesn’t come with the IMF imprimatur that reassures many investors. And it is far from clear how this money will make its way into the economy to maximize the potential for currency stabilization.

And then there is the trade skirmish with the US.

Like other countries, it is only a matter of time until Turkey comes to the same realization as others about confronting the more protectionist stance adopted by the US. Because of its size and systemic influence, and assuming it remains willing to incur the risk of suffering some damage in the process, the US is destined to win a tit-for-tat tariff escalation. As such, the best approach is what the European Union decided to do last month: seek a way to pause the skirmish while working on the longer-term underlying issues.

Rather than rewriting the game plan for crisis management in emerging markets, Turkey may well end up confirming it. One hopes this will lead to the restoration of financial stability and growth as the government looks to reverse its stance on central-bank independence, interest-rate policy, and perhaps even the IMF. The alternative – persisting with the current approach and, in the process, running the risk of turning technical dislocations into much more damaging longer-term economic and financial disruptions – would also prove problematic for other emerging economies.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, 2011, and 2012. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

One Belt, Many Headaches

The centerpiece of BRI is in Pakistan, a place not known for its security or financial stability.

By Phillip Orchard


As Beijing planned it, Pakistan was to be the centerpiece of its sprawling Belt and Road Initiative. Centered on what’s being called the China-Pakistan Economic Corridor, China has pledged backing for some $62 billion in port, road, rail and other projects along a 1,700-mile (2,700-kilometer) belt connecting a deep-water port at Gwadar to Kashgar in the western Chinese region of Xinjiang. CPEC embodies Belt and Road’s grandest strategic and economic ambitions. If successful, it would open a critical trading route to the Indian Ocean, allowing China to bypass chokepoints in the Pacific. It would help modernize underdeveloped economies in remote, restive regions of China, expand China’s commercial influence, pull Pakistan more firmly into its orbit, and counterbalance India’s warming military relationship with the U.S. and its allies.  
Yet, CPEC is also proving host to some of BRI’s thorniest challenges. On Saturday, for example, Baloch separatists targeted a bus carrying Chinese engineers to a CPEC project, killing three in the suicide attack. Unlike past attacks on CPEC projects, the separatist group said this one directly targeted Chinese nationals. Meanwhile, CPEC has helped push Pakistan into a deepening debt crisis, putting the project at the center of the burgeoning U.S.-China competition in the region and likely forcing Beijing to open its wallet further. These challenges aren’t going to derail CPEC; in fact, China may be able to exploit them for strategic benefit. But one way or another, the road ahead is likely to get only rockier from here.
Security Risk or Strategic Opportunity?

The Aug. 11 attack on Chinese engineers is just the latest in a string of low-level incidents targeting CPEC projects. In Balochistan alone, militant attacks on CPEC projects are estimated to have killed 44 workers and injured over 100 (most of them Pakistani) from 2014 to 2016. Yet, at this point, the security challenges have proved largely manageable for Beijing. The estimated 40,000-70,000 Chinese nationals working in the region have been targeted directly only a handful of times. This is no small feat considering that CPEC’s 1,700-mile route runs through some of Pakistan’s most restive areas – in addition to Balochistan, Kashmir in the northeast and Khyber Pakhtunkhwa to the west. Chinese projects will, at minimum, complicate age-old disputes between local opposition and the state in these regions.

Beijing has gotten ample help from Islamabad, which allocated some $17 million this year to CPEC security. Most of this is going to a Special Security Division, consisting of some 9,000 army troops and another 6,000 paramilitary, which Pakistan launched specifically to protect Chinese nationals and CPEC projects. Provincial governments are also pitching in. The Khyber Pakhtunkhwa government, for example, is expected to stand up a new 4,200-member security force to secure China’s ever-expanding footprint.

China has also found ways to take matters into its own hands. In February, Pakistani officials and several tribal sources told the Financial Times that Beijing had been holding clandestine talks with Baloch militants for more than five years. China has deep experience with protecting its far-flung investments in this way. For example, China has become an indispensable arbiter in the patchwork of ethnic rebellions in northern Myanmar (home to a proliferating number of Chinese mining and infrastructure projects). It’s had success navigating the treacherous militant landscape in the Afghanistan-Pakistan region as well. In 2000, a senior Chinese diplomat was reportedly able to secure cooperation from Taliban leader Mullah Mohammad Omar to prevent Uighur militants from conducting attacks in Xinjiang. Four times in the past decade, Beijing has blocked U.S. and Indian bids at the U.N. to designate Masood Azhar, the leader of the anti-India militant group Jaish-e-Mohammed, as a “global terrorist,” presumably in exchange for protection for Chinese projects in Kashmir and on both sides of the Afghan border.

Still, the Chinese Embassy in Pakistan has repeatedly warned that security risks are likely to worsen, and Beijing has signaled that it has little tolerance for failure from Islamabad on the security front. Shortly after two Chinese teachers in Balochistan were kidnapped and killed by Islamic State militants last year, for example, Chinese President Xi Jinping publicly snubbed Pakistani President Nawaz Sharif at a Shanghai Cooperation Organization summit. If attacks on Chinese nationals intensify, it won’t be hard to imagine Beijing pushing for a more direct role – say, something akin to its presence in South Sudan, where thousands of Chinese troops have been deployed as peacekeepers to protect Chinese oil interests. China has a massive and largely idle military that is almost entirely bereft of combat experience, after all.

In this way, while the security risks with CPEC may be a headache for Beijing, they’re also opening strategic opportunities. Beijing is keen to extend its security footprint in South Asia and into the Indian Ocean basin. It wants naval access to the deep-water port it’s building at Gwadar, or possibly the green light from Islamabad to build a dedicated naval and air base farther to the west in Jiwani, close to the Iranian border. (Unconfirmed reports claim that preliminary talks on the Jiwani base were held in December.) It’s looking for leverage to discourage India from wading into China’s various disputes in Southeast Asian waters. And it’s hell-bent on denying Uighur militants sanctuary in the Himalayas and smashing up support networks for their operations in Xinjiang. Theoretically, at least, making Pakistan more dependent on its security partnership with China would advance each of these aims.

Of course, the more China goes down this route, the more it may intensify militant resistance to Chinese projects, prove politically untenable for any government in Islamabad and put the future of CPEC further in doubt. Indeed, the separatists behind the Aug. 11 suicide attack in Balochistan said their motivation was China’s provision of arms to Pakistan for use against Balochistan’s national struggle. Beijing may conclude that it can ill afford the great responsibilities that come with great power – that getting bogged down with another country’s intractable problems is a tried and true way for an aspiring superpower to get overextended and collapse under its own weight (see: the Soviets). In Pakistan, as in other BRI countries where Beijing is sinking money into commercially infeasible projects no one else would touch, China is grappling with this dilemma on the financial front as well.
The Pitfalls of Debt-Trap Diplomacy
Put simply, the economics of CPEC are a mess, and the $62 billion project is likely contributing to a financial crisis that the next prime minister, cricket legend Imran Khan, will inherit when he’s sworn in on Aug. 18. Over the past 20 months, Pakistan’s foreign currency reserves have dropped by half, to less than $10 billion, while the Pakistani rupee has lost nearly 20 percent of its value against the U.S. dollar since the beginning of the year. Its current account deficit has grown more than 40 percent in just two years. Its external debt is approaching 30 percent of gross domestic product. Pakistan’s chronic financial woes predate CPEC; Islamabad has gone through 12 balance of payments support programs with the International Monetary Fund just since 1980, including a $6.6 billion program that was completed only two years ago.

It’s hard to say exactly how much CPEC is making matters worse, in part because the project is notoriously opaque. In late 2015, the governor of the State Bank of Pakistan conceded that the government was not clear on how much of the funding pledged by Beijing was debt, aid or equity. But the terms that have been released don’t give much confidence in Pakistan’s ability to live up to its end of the bargain. For example, Pakistan reportedly guaranteed Chinese power plants annual returns as high as 34 percent over the next three decades. Islamabad is believed to be on the hook for any shortfalls, not to mention dollar-denominated debt repayments that at the moment are looking ever-more expensive as the U.S. dollar surges. Pakistan’s last government insisted it had gotten a handle on the issue, asserting that the country’s total annual debt repayments and profit expatriation by Chinese companies would be below $1 billion for the next five years – and that lengthy repayment periods give Islamabad ample breathing room. Still, at minimum, rising imports of Chinese materials needed for CPEC projects are considered a major driver of the balance of payments crisis.

Regardless, the new government in Pakistan has little choice but to seek an estimated $12 billion to $14 billion bailout – the country’s largest ever. Pakistani officials are reportedly planning to first turn to the IMF, from which Pakistan is eligible to receive around $9 billion. However, on July 30, U.S. Secretary of State Mike Pompeo said the U.S., the second-largest vote-holder in the IMF, would oppose an IMF rescue if it meant using IMF funds (to which the U.S. contributes) to repay Chinese lenders.

This poses a problem for Beijing: If Pakistan agrees to terms with the IMF that include prying open the books on CPEC – and if terms made public expose Chinese predatory lending – it would undermine China’s BRI ambitions elsewhere at a time when a number of BRI partners have been seeking to cancel or renegotiate projects. Of course, it would also risk an anti-China political backlash in Pakistan itself. The alternative is for Beijing to carry more of the rescue burden itself, but this means throwing more good money after bad. (Over the past year, China has provided some $5 billion in new lending to Pakistan, including a $2 billion emergency loan shortly after the general election late last month.) To date, the value of CPEC projects that have broken ground amounts to less than a third of the total pledged, so completing CPEC as envisioned by Beijing could mean a lot more good money disappearing into the Himalayan ether.

On the one hand, the more Pakistan becomes indebted to Beijing, the more leverage Beijing will ostensibly have for strategic issues – such as permission to build that shiny new naval port. This scenario is what foreign leaders are referring to when warning about China’s “debt-trap diplomacy.” Sri Lanka’s BRI experience is illustrative in this regard, where China backed a commercially dubious deep-water port and airport project and, once Sri Lanka realized just how far revenue projections were going to fall short, secured a 99-year lease for the warship-accessible port. Yet, while China may be growing rich, it can’t afford to give its BRI partners a blank check, particularly while it’s scrambling to manage its own debt crisis at home. Indeed, Beijing has begun scrutinizing BRI projects more closely and leaning on state firms to find ways to boost revenue. In the first half of 2018, Chinese foreign direct investment channeled to BRI projects dropped 15 percent year-over-year. Indeed, in Pakistan, a $9 billion flagship rail line has been put on hold.

The downside of being a creditor nation is that, if you really need the money back – or if you really need the project you’re financing to be completed and (in China’s case) serve fundamental strategic imperatives – the debtor holds quite a bit of leverage and incentive to keep asking for more. The same logic applies loosely to whatever Beijing is promising militants in BRI states to get them to hold their fire. China’s experience in Pakistan is showing just how much strategically motivated beneficence can be a double-edged sword.

The Future of Everything

Strawberry Jam: Urban-Farming Startups Tackle a Problem Crop

If shipping-container farms are going to feed the world, their backers will have to find an economical way to grow the popular fruit indoors

By Mike Cherney

SYDNEY—In a rush to turn old factories and shipping containers into high-tech urban farms, entrepreneurs likeFrancisco Caffarenaare in a jam: Strawberries are proving surprisingly troublesome.

Growing crops indoors in cities can help feed the world’s expanding population—and appeal to affluent locavores willing to spend more on produce grown nearby. Meanwhile, extreme weather associated with climate change means new challenges for conventional farmers.

“Fifteen years from now, will there be such a thing for a producer of crops as a traditional, normal season?” saidJason Wargent,an associate professor of horticulture at Massey University in New Zealand and chief science officer for BioLumic, a startup researching ultraviolet-light treatments for plants. “You’re going to need every tool in the box.”

Indoor farming has attracted some big-name investors. Last year, investors including Japanese conglomerate SoftBank and funds tied to Amazon’sJeff Bezosand Google’sEric Schmidt pumped $200 million into an indoor-farming startup called Plenty.

Some startups have already successfully grown leafy greens indoors. Strawberries, with short growing cycles and relatively small plants compared with fruit-bearing trees, are in theory good candidates for urban farms. Strawberries are also very popular: Retail sales in the U.S. reach roughly $3 billion annually, according to the California Strawberry Commission.

But strawberry plants require a lot of light, which means higher electricity costs. And unlike leafy greens, they have flowers that need to be pollinated. On a traditional farm, bees and other insects do this for free. In a shipping container, the most reliable—yet expensive—pollinator is a human worker.

Solving the strawberry conundrum could be the difference between shipping-container farms being a niche business supplying local supermarkets and restaurants, or a more significant production source for a wider variety of crops. New techniques and technologies developed to help pollinate the strawberry flowers could be used for other fruits. 
Mr. Caffarena, whose company, Sprout Stack, is already growing lettuce and herbs in a shipping container in Sydney, sees several possible strawberry solutions, including racks that could be lightly vibrated, knocking loose pollen and fans to blow the particles around. Other companies say workers could be cost-effective in certain locations. Still others think robots might be able to help.

In Paris, a startup called Agricool is using bumblebees for pollination in four containers it has growing strawberries.

“I find it therapeutic to hand brush pollen on a strawberry, but some people might go, ‘That’s really painful,’” saidJames Pateras,director at Modular Farms Australia, another company that wants to retrofit shipping containers to grow crops.

Plenty, whose website until recently highlighted lettuce, mint and strawberries as crops, declined to discuss its farming methods.

Heather Szymura in Glendale, Ariz., bought a container farm from a company called Freight Farms and is now growing strawberries in it. Photo: Heather Szymura 

Some agricultural scientists are skeptical about container farms. Most strawberries in the U.S. are grown in California, where the climate along the coast offers ideal conditions: cool but typically not freezing nights, and warm days that usually aren’t too hot, saidGerald Holmes,the director of the Cal Poly Strawberry Center, part of California Polytechnic State University in San Luis Obispo, Calif.

If a startup can “produce strawberries in the dead of winter on a roof somewhere in Chicago or Toronto, now there’s a niche,” Mr. Holmes said. “If you just put it head-to-head against field production in coastal California, that’s going to be very difficult to show that you can do that economically at anywhere near the same price.”

In North Carolina, a company called Vertical Crop Consultants recently designed a container-farming system that it says could grow 7,000 pounds of strawberries annually.Tripp Williamson,the chief executive, says he recommends hand pollination by workers. The first units were recently sold to clients in Trinidad and the Cayman Islands, where strawberries are expensive in supermarkets.

At home, however, Mr. Williamson said strawberries, depending on the season, could cost as little as $2 per pound at retail. He said the container system—called a CropBox—wouldn’t make economic sense for strawberries unless the grower could get $5 or $6 a pound wholesale.

“You can grow anything in a CropBox,” he said. “You could put one or two banana trees in there and grow some bananas, but it’s going to be so expensive that you wouldn’t get any payback from it.”

In Glendale, Ariz.,Heather Szymurabought a shipping container from a company called Freight Farms in 2015—and about six months ago, she began growing small batches of strawberries. Some have turned out “really sweet and really juicy,” she said.

Pollination hasn’t been a problem, she said, but she has been handling the plants a lot and that could have helped spread the pollen. Air flow within the container could also be playing a role, she said. She hasn’t set a market price for the strawberries yet, but has sold other crops to chefs willing to pay more for quality and novelty.  
“I have been able to baby these plants and pick off the dead leaves and make sure everything is looking the way it should,” she said of growing strawberries. “If I had a container full, I think it would take a lot of time.”