The analysis of emerging markets is (partly) different

08:11 by Hubert Fromlet, Kalmar

Many analysts think that the important country group of emerging markets currently is on the edge of a new crisis. May be – or may be not. We do not know yet – but increasing risks are certainly visible. Six of them are – or may be – most challenging. They are:

– domestic and global political risks, increasing protectionism included,

– rising interest rates in the U.S.,

– weakening economic growth in the advanced countries,

– contagion among emerging countries,

– increasing global risk aversion from OECD countries in emerging countries,

– accelerating psychological exuberance without consistent fundamental basics.

We have to recognize that emerging markets still depend to a high degree on developments in OECD countries – despite the fact that emerging economies already today have a higher share of global production (in PPP terms) than all the advanced countries (but with markedly lower GDP per capita than the first group of countries).

Special characteristics of emerging markets

Thus, the analysis of emerging markets must include developments in OECD countries but also certain own characteristics of emerging countries . If we watch these special characteristics from a risk perspective, factors like political and social risks, institutions, maturity of financial markets, economic reforms and stability in general terms play a particularly big role – mostly considerably more than in a mature country; this is, of course, exactly why we have this distinction between mature (advanced) and emerging countries.

The current account balance – often neglected by analysts

Sometimes also two other developments or indicators can become decisive for the development of an emerging market – the current account balance and foreign debt. In mature countries, these two economic indicators are not focused very carefully (with the Greek crisis a couple of years ago as an outstanding exception).

Normally, there are no particular analytical emergencies in this specific respect. But they occur. However, even professional economists appear sometimes very unskilled when it comes to knowledge and interpretation of current account deficits. This happens mostly when emerging countries are derailing.

Current account deficits mean that a country has more imports than exports of goods, services and cross-border financial transfers like the interest rate and dividend payments.

Unfortunately, the consequences of a substantial and persistent current account deficit sometimes turn out to be very negative. Of course, emerging markets can run limited deficits in cross-border business – may be up to 4-5 percent of GDP or so without any distortion; however, the internationally “accepted” upper limit is not static and certainly interpreted more strictly when the current account deficits worsen further and/or economic or political problems increase. At the end of the day, the international financial and non-financial community may lose confidence in the country.

In reality, a current account deficit reflects a negative national savings performance. This means a debt in foreign currency vis-a-vis-other countries. This negative outcome has to be financed by inflows of foreign currencies. This can happen by definition in three ways:

– foreign direct investments (FDI; if foreigners still are interested when problems increase sharply),

– borrowing money abroad,

– selling stocks and bonds to foreign portfolio investors (if there is a capital market in the emerging country) – which also may become a major risk when foreigners because of increasing doubts suddenly sell these papers again.

The case of a big crisis

It also happens that current account deficits develop into an alarming crisis. This may happen when simultaneously a credit bubble is bursting. Another critical development may show up when there is a major minus in the current account and foreign debt is high at the same time.

Even worse: when in such a situation with a very weak current account balance and high foreign debt a substantial part of this foreign borrowing is short-term based. Such a situation can aggravate further when also the affected country’s currency more recently has been weakening largely – which recently happened in Turkey. In this specific case, foreign debt grows further.

Adding, for example, in the analysis of Turkey’s substantial deficits in the current account the high amounts of short-term foreign debt, it is quite easy to understand the uncomfortable future risks of the Turkish economy.

Still a lot of work to do

Above, some of the above-mentioned risks demonstrate very well that the analysis of emerging countries may differ quite a bit from the analysis of mature countries. This concerns particularly institutions, the balance of current account and the amount and also structure of foreign debt.

This kind of necessary expertise cannot be achieved by occasional studies of emerging countries. Instead, a lot of regular and deepening research and analysis is needed (otherwise, no applicable or reliable forecast on an emerging market economy can be launched).

Unfortunately, we are still far away from ideal preconditions for the analysis of emerging market countries. A lot of more homework has to be done also in our part of the world.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board


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