Trouble with BRICS: High debt, current & trade account deficits are reducing them to BIITS

To paraphrase writer Robert Louis Stevenson, financial markets have "a grand memory for forgetting". The Latin debt crises and the 1997-98 Asian emerging market crisis have been forgotten.

Now, the risk of an emerging market crisis is real. Slowing growth in developed economies after the 2007-08 financial crisis resulted in a slowdown in emerging economies. So, emerging markets switched to development models reliant on credit.

Double-digit annual credit growth drove economic activity in Brazil, Russia, India and China, as well as Turkey and many economies in Asia, Latin America and eastern Europe. Easy money in developing countries encouraged capital inflows into emerging markets, in search of higher returns and currency appreciation.

Asset prices, particularly of real estate, increased sharply. In the last 12 months, investor concern about developments in emerging markets has increased, reflecting slowing growth and a potential reversal of capital inflows. The growth slowdown is now attenuated by capital outflows, driven by concerns about emerging market economies and changing US policy dynamics.

Improvements in US' economy have encouraged discussion about "tapering" the US Federal Reserve's liquidity support, currently $85 billion per month. US Treasury bond interest rates have increased, with the 10-year rate rising by nearly 1% per annum in anticipation of inflation. Germany has also hiked rates.

Emerging-market central banks, excluding China, have seen outflows of around $80 billion, around 2% of total reserves. Over the last four months, Indonesia has lost around 14% of central bank reserves, Turkey 13% and India around 6%.

Can't tide over

An outgoing tide reveals the treacherous rocks that lie hidden when the water level is high. Slowing growth and capital withdrawal are exposing deep-seated problems, especially high debt levels, financial system problems, current and trade account deficits and structural deficiencies.

Debt levels in emerging markets have risen significantly, with total credit growth since 2008 in the range 10-30%. Credit growth has been especially strong in Asia. Total debt-to-GDP above 150-200% is now common. Credit intensity has also increased sharply.

New credit needed to generate each extra dollar of GDP has doubled to $4-8. In many emerging countries, quasi-government bank officials have financed projects sponsored by politically connected elites. Lending practices have been weak, helping finance property and vanity projects with dubious economics.

Many borrowers will struggle to repay debt. Losses are hidden by a policy of restructuring potential non-performing loans. Bad and restructured loans at Indian state banks have reached around 12% of total assets, doubling in the last four years.

The current account surplus of emerging markets has fallen to 1% of combined GDP, from around 5% in 2006. This reflects slow growth in export markets, lower commodity prices, higher food and energy import costs and domestic consumption driven by excessive credit growth.

India, Brazil, South Africa and Turkey have large current account deficits, which must be financed overseas. India has a current account deficit and a budget deficit close to 10% that requires funding. Emerging countries require around $1.5 trillion every year in external funding to meet financing needs, including maturing debt.

A deteriorating financing environment combined with falling currency reserves, reduced cover for imports and shortterm borrowings, declining currencies and lower economic prospects have increased their vulnerability.

Mid-level crisis

The difficult external environment has highlighted structural weaknesses. Investors fear that many emerging markets may be caught in a middle-class-income trap, where countries experience a sharp slowdown in economic growth when GDP percapita reaches around $15,000.

Weak growth in developed markets and decreasing credit quality of developed country sovereign bonds may adversely affect emerging markets. Emerging countries have also lost competitiveness as a result of rising costs, especially of labour.

Vanity affair

Many investments have been misdirected or deliberately wasteful. Trophy projects, such as the 2008 Beijing Olympics, costing $40 billion, Russia's $51-billion 2014 Sochi Winter Olympics and Brazil's 2014 football World Cup and 2016 Olympics have absorbed scarce resources at the expense of essential infrastructure.

Inequality, graft, hostile business environments, concentration of economic power in state corporations and political rigidities compound the problems of debt and capital outflows. Political uncertainty in Brazil, Turkey, South Africa and India compounds the problems.

All this means that the romance with the Brics has fallen to Biits, the acronym for the most vulnerable emerging markets, Brazil, India, Indonesia, Turkey and South Africa.

PRAVEEN SHARMA

PGDM