The Reform Pattern of the EU Debt Crisis reaches the Emerging Markets

Dialogue with the Alter Ego on international currency turbulences

Question by Alter Ego of Noah denkt™ (AE): In the last couple of days markets have been spooked by the Argentina currency crisis and the fear that subject crisis might                  spread to other emerging markets after the FED’s tapering announcement. Meanwhile, however, the general consensus in the markets seems to be that this is a passing storm and that only a few very badly managed emerging markets will continue to suffer from the tapering effect in the US.  What is Noah denkt™’s position on this?

Answer by Noah denkt™ (Nd): We believe that markets won’t be able to shrug this off as easily as our first intuition might have suggested.  Instead we fear that this could be the beginning of a more sustained period of uncertainty surrounding the emerging market success story.

AE: Why do you say that?

Nd: Well, it seems to us that Brazil, for instance, which is currently been viewed as a pillar of emerging market success is very much exposed to the negative effects of the Argentinean crisis.  Its current account balance (-8677.60 Million US$) is trending negatively. Its foreign reserves are coming down; and the GDP growth rate there is slowing down as well. Beyond that, however, we also need to recognize that Argentina is Brazils 4th biggest export and import market. And clearly there are huge structural deficiencies in Brazil – as in deed in all other emerging markets (corruption, underperforming educational system etc) – that may well come under serious scrutiny in the coming months.

AE: So you are saying that if doubt spreads over Brazil, many other emerging markets won’t be able to duck the negative fall-out from this as well.

Nd: Correct.

AE: Nevertheless, the bulk of statistics with respect to Brazil is positive. GDP is growing, unemployment is coming down, labor costs are decreasing, the amount of external debt is falling, and foreign direct investment continues to be high. And then there is the fact that the World Soccer Championship and the Summer Olympics will soon be hosted in Brazil. It, hence, seems quite outlandish to believe that this country’s reputation could come under serious threat.

Nd: It is possible that the international perception of Brazil’s credibility might save it from the fact that its fundamentals aren’t as good as conventional wisdom has it. But this is a very thin ice we are treading here. Because who would have thought just a week ago that India or Turkey might enter into turbulences. Let’s look at India, for instance: Although its current account balance is negative the latter is still trending in the right direction. At the same time its GDP is growing, its foreign exchange reserves are high, and its government hasn’t committed major mistakes in its economic and social management recently.  So why did its central bank have to spike the interest rate in order to defend the national currency?

AE:  Because at the outset the emerging market storm was indiscriminate. As time goes by though, the markets’ view will become more differentiated and understand that not all emerging countries can be lumped in the same basket.

Nd: We are not so sure about that. Instead it seems to us, as if the rescue pattern of the Euro debt crisis might now spread elsewhere. In other words, it seems to become clear that it isn’t just the Eurozone which is being forced into major structural reforms by the fall-out of the devastating sub-prime crash, but that it is the world as a whole which will have to augment its economic competitiveness in order to avoid a serious breakdown.

AE: So, the sub-prime crash will bring about a major paradigm shift in economic, social and international relations?

Nd: That is what it looks like now.

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