East Capital’s Marcus Svedberg looks to impact of ongoing deficits in emerging markets

Marcus Svedberg,chief economist at East Capital, has reviewed the impact of the US Federal Reserve’s tapering activities on current accounts of emerging markets, but also the factors that could determine which ones do better going forward.

One result of the whole tapering debate is that balances of payment have become crucial in the economic and financial analysis again. The reason is that once the Fed and other central banks start to reduce their quantitative easing, global liquidity will shrink making it more difficult and costly to finance current account deficits. This is expected to hit the emerging world relatively hard as many countries have relatively sizeable deficits as a share of GDP although developed economies like the US and UK have the largest deficits in absolute numbers.

There is a rule of thumb suggesting that current account deficits become really problematic when they exceed 5% of GDP. That is a reasonable starting point but it is important to look beyond the headline figure when determining how much of a problem the deficit could become. We will therefore make a quick overview of not only the current deficits for all emerging markets, but also look into the trend, the source, the structure, and the financing of the deficits of the emerging markets with the largest deficits. We will then conclude with a discussion of overall vulnerability.

Current Account Deficits 2012-14 (% of GDP)

svedberg-chart11Source: IMF

It is clear from the table that Turkey, South Africa and India are the most vulnerable from a simple comparison – although it should be pointed out that there are 65 frontier (or unclassified) markets with even larger deficits. The situations in Turkey and South Africa are particularly worrying as the deficits are expected to widen further. Brazil is also expected to develop in the wrong direction as are a number of surplus countries, such as Russia and Malaysia, although the levels do not pose a major problem in the short term, at least not on their own merits.

The sources differ

In Turkey and India large energy deficits explain a major part of the current account deficit (CAD), together with relatively low value added net exports, whereas Brazil, Indonesia and South Africa are substantial commodity exporters. Brazil and Indonesia have a relatively balanced trade but are hit by large negative income transfers, such as foreign repatriation. South Africa has a negative trade balance as well as negative income transfers.

The source of the deficits tells us little about the short term trend of how the CAD will develop. The deficits are expected to widen in Turkey, South Africa and Brazil, while they are assumed to narrow in India and stay more or less flat in Indonesia. But it can give us a clue of the longer term development. It is arguably very difficult for the commodity dependent countries to structurally lower their deficits in the short-medium term although their deficits will come down automatically if growth slows and/or commodity prices drop. They can also try to enhance value-added exports and domestic energy production.

The CAD countries with sizeable negative income transfers may seem better off as their problems are less structural in nature. But there are fewer concrete policy options available and they could be squeezed since they could face substantial deficits even if growth slows. Put differently, there are no automatic stabilizers.

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