It doesn’t happen often, but the UK is out-performing the BRICS, the fast-growing emerging market nations of Brazil, Russia, India, China and South Africa. OK, maybe not in nominal terms, but the latest IMF world growth report revised up the outlook for the UK economy at the same time as it revised down its forecast for China, Brazil, Russia, South Africa and India.
The IMF now expects the UK economy to expand by 0.9% this year, up from its 0.7% April forecast. This is still below its prior forecast of 1%, however you could argue that 0.1% is just a rounding error. So what is the UK doing right and what are the BRICS doing wrong?
In fairness the woes now befalling the emerging markets are not all home-grown. A perfect storm of a flare up of stresses in the Middle East, a slowdown in the commodity sector and the Federal Reserve in the US slowly shifting to a more neutral monetary stance, away from a dovish position, are all playing their part.
The latter point is particularly worth noting. Since 2009, interest rates across the developed world have been close to zero. Added to this, central banks in the US, UK and Japan have embarked on unconventional monetary stimulus to keep yields on longer-dated government debt as low as possible. During this time investors were starved of yield, so they started piling money into stock, bond and currency markets of the higher yielding emerging world.
However, in the last few weeks the tables have turned. The Federal Reserve in the US looks like it is poised to end its extraordinary period of quantitative easing and government bond yields in the developed world have been on the rise. Added to this, the US dollar has risen sharply; the greenback is up 5% over the past month and some analysts are expecting even larger gains over the next year. US stock markets rose to record highs earlier this year and all of a sudden the developed world, particularly Japan and the US, is starting to look like an attractive destination for investors’ capital.
This triggered sharp sell offs in emerging currency and bond markets in the last few weeks, with the Indian rupee falling to a record low versus the USD and countries including Brazil and Turkey implementing capital controls to try to limit the relentless decline in their currencies and avoid a negative inflationary spiral.
What started off as a slide in the FX market has been squared and cubed, as interest rates rise to try to curtail currency declines this weighs on credit growth, which dents future investment and GDP potential, making the emerging world even less attractive in investors’ eyes.
The situation in emerging markets is a keen reminder of the fragility of their economies. Protests in Brazil, Egypt and Turkey highlight the social consequences of high levels of unemployment, wealth inequality and low levels of investment in public services. In the recent times, when money was flowing without a care in the world, the cracks in the economies and political dynamics of emerging markets were easy to ignore. Things are different now. In the words of investment guru Warren Buffett, we only learn who is swimming naked when the tide goes out. The giant wall of money is definitely receding from the emerging world.
It is worth noting that emerging markets are better protected to weather economic storms than they have been in the past, FX reserves are at their highest ever level, with China alone having a $3.4 trillion capital buffer. However, is this enough for them to stand on their own two feet, without the help of Fed liquidity?
Structural challenges, both social and economic, continue to exist in the emerging world and it will take a long time to fix these. In the UK we have plenty of structural problems of our own, but we have had a head-start on dealing with them compared to the emerging world. After a bleak few years, at last there is some light at the end of the UK’s economic tunnel.
The emerging world should use this mini-crisis to reform their economies, make their societies fairer and work towards being less reliant on the West for capital and trade flows. If this happens then investors will have their bathing suits at the ready.