Story Originally Appeared in Bloomberg News
Stretched budgets and sluggish growth are putting emerging-market governments on a collision course with rising pressures from recently empowered middle classes for more spending and better services.
From Jakarta to Brasilia, policy makers face the end to an era of abundant global liquidity that helped fuel the fastest expansion in three decades. In the eight weeks through July 17, investors pulled $40.3 billion from emerging-market bond and equity funds amid signs the Federal Reserve may begin reducing stimulus later this year. In 2012, $111 billion poured into these asset classes, according to EPFR Global in Cambridge, Massachusetts, which tracks money flows.
The Fed’s plans didn’t trigger the slump -- after a decade of prosperity, the BRIC economies of Brazil, Russia, India and China (SHSZ300) have been slowing since 2010. Developing nations are punished more during downturns than their European counterparts because they depend on growth to mitigate social tensions, said Angel Gurria, secretary-general of the Organization for Economic Cooperation and Development.
“The needs are much more elementary and brutal,” said Gurria, a former Mexican finance secretary, in a July 19 interview in Moscow. Families live with “vermin because they don’t have cement on the floor, and when there’s a big wind it blows off the roof. This isn’t the problem the middle class in the Netherlands face.”
Nomura International Plc, citing the “surprise” outbreak recently of protests in Brazil and Turkey (XU100), said 11 other countries -- including China, India and Russia as well as commodity exporters Argentina and Venezuela -- face the risk of market-moving civil unrest in the short to medium term. Frustration with corruption by a middle class that swelled during the past decade is partly fueling the angst, according to its June 27 report.
“If you lift your people out of extreme poverty, it’s not like they’re going to say ‘Great, now we’re all set, we don’t want anything else,’” said Jim Yong Kim, president of the World Bank, in a June 30 interview in Lima, Peru. “This is not going to go away. This is the most natural thing in the world.”
Investors can ride out the volatility by betting on governments that resist populist pressures for more spending and instead shore up long-term financial stability, said Ruchir Sharma, who helps manage $25 billion in emerging-market stocks at Morgan Stanley Investment Management in New York. He says his group is underweight China, Brazil and Russia and overweight Mexico and the Philippines.
Mexico is benefiting from a stronger U.S. economy, and first-year President Enrique Pena Nieto is trying to open up the state-run oil industry. The Philippines is forecast to grow 6.2 percent this year, according to a Bloomberg survey of economists, on the back of a recent tax overhaul.
“There are positive stories as well,” said Sharma in a telephone interview from New Delhi. “The selloff has been indiscriminate, but once the dust settles, the attention will turn back.”
The MSCI Emerging Markets Index has fallen about 9 percent since May 21, the day before Fed Chairman Ben S. Bernanke said the central bank could scale back its $85 billion in monthly bond purchases if the U.S. job market keeps improving. In Brazil, stocks have slid 14 percent since then, while the real has fallen to a four-year low. Stocks in Turkey and China also have posted double-digit declines. In contrast, the MSCI World Index of advanced nations is little changed.
Officials still have the ability to defuse underlying social tensions, having strengthened their finances since the last spate of emerging-markets crises toppled governments from Indonesia to Argentina starting in the late 1990s, said Alastair Newton, the London-based Nomura political analyst who wrote the bank’s report. Only now they’ll need to balance the mood in the streets with the discipline demanded by markets in the context of slowing expansions and tighter budgets.
The International Monetary Fund cut its global growth forecast on July 9 for the fifth consecutive time, saying a leveling off in China and the risk of capital outflows present new challenges to nations that have propelled the world economy. Developing countries will expand 5 percent this year, down from a 5.3 percent forecast in April and an annual average of 6.6 percent during the past decade, according to the IMF.
Finance Minister Lou Jiwei has signaled China’s economy may expand less than the government’s target of 7.5 percent. At a July 11 press briefing in Washington, he said he’s confident 7 percent can be achieved this year and growth as low as 6.5 percent may be tolerable in the future.
One country already feeling the squeeze is Indonesia, where President Susilo Bambang Yudhoyono last month stared down demonstrations and ordered cuts to fuel subsidies. The move, which raised gasoline prices by 44 percent, recalled austerity pledges that fueled protests and led to the collapse in 1998 of Suharto’s three-decade regime. Fifteen years later, under democratic rule and with an economy still forecast to grow about 6 percent this year, reaction has been more muted even as investors have pushed the rupiah down near a four-year low.
“This is a very good example of how you don’t need to spend more money to reallocate resources better,” said Gurria in the interview on the sidelines of a Group of 20 finance-ministers meeting.
Like Indonesia, the world’s largest producer of palm oil, Brazil is another commodity exporter that stands to lose from China’s slowdown. Both countries -- along with Egypt, where Mohamed Mursi was ousted from the presidency this month amid the worst economic slump in two decades -- are raising interest rates to fight inflation, which could damp growth even further.
President Dilma Rousseff, in the aftermath of Brazil’s biggest street revolt in more than 20 years, vowed to keep a lid on spending even as she addresses protesters’ demands for better schools, hospitals and public transportation. She’s also begun unwinding capital controls put in place during the past five years to protect Latin America’s biggest economy from what she’s called a “currency war” unleashed by rich countries.
The unrest and sluggish growth in emerging markets, which now account for nearly half the world’s economic output, threaten to erode company profits. Coca Cola Co. (KO) Chief Executive Officer Muhtar Kent said July 16 that the protests in Brazil and the Middle East contributed to an “unusually weak” second-quarter performance.
The expansion of the middle class -- defined by the World Bank as earning more than $10 a day in Latin America -- is reshaping politics around the globe, according to South African Finance Minister Pravin Gordhan.
“It creates anger that some people are getting away with a lot of the growth process and others not so,” he said in a July 19 interview from Moscow.
About 50 million people in Latin America alone rose out of poverty during the past decade, joining a group that now accounts for 30 percent of the region’s population, the World Bank said last year.
To be sure, emerging markets aren’t heading toward another 90s-style balance-of-payments crisis, said John Williamson, who retired last year as a senior fellow at the Peterson Institute for International Economics in Washington. Two decades ago, he coined the term “Washington consensus” to praise the free-market policies then being embraced around the world.
Governments that committed the so-called original sin of selling bonds in dollars have reduced their external vulnerabilities by building up record currency reserves and issuing more debt locally. Most countries also have embraced free-floating exchange rates, and inflation in emerging markets, averaging 5.9 percent according to the IMF, is less than half 1995-2004’s 13.1 percent.
“These buffers are extremely important,” Williamson said in a telephone interview. “The market reaction has been exaggerated. I don’t see any major reason to expect a slowdown in growth in the long run.”
That’s small comfort to governments struggling to stay ahead of the rising expectations of disaffected young people, said George Friedman, chief executive officer of policy-risk consultant Stratfor.
“There’s a number of regimes who’ve built their legitimacy on fast growth,” Friedman said in a telephone interview from Austin, Texas, where Stratfor is based. “When they can no longer deliver, they’re setting themselves up for a huge fall.”
Reflecting that anxiety, Turkish Prime Minister Recep Tayyip Erdogan blamed social media for fueling protests against his government’s plans to build a shopping mall in an Istanbul park.
“Right now, the same game is being played in Brazil,” Erdogan told supporters in the northern province of Samsun on June 22. “The symbols are the same, the posters are the same. Same Twitter, same Facebook, same international media. They are being controlled by the same center.”
If turmoil does spread around the world, leaders who have held power longer could be voted out of office or see support plunge, Sharma said. These include Vladimir Putin in Russia, Prime Minister Manmohan Singh’s nine-year government in India and the decade-long run for Rousseff’s Workers’ Party in Brazil, he said.
In the wake of Brazil’s protests, approval of Rousseff’s government plunged to 30 percent from 57 percent in June, putting at risk an expected re-election bid next year.
“The same incumbents who benefited from the boom are now facing the wrath of the electorate,” said Sharma, whose 2012 book “Breakout Nations” criticizes the BRICs for not investing wisely during the boom years. “Leaders didn’t fully realize how much was due to global factors and not their governance.”
While an anti-incumbent wave may be gaining momentum around the world, not all governments will face rejection just because growth disappoints, Gordhan said.
“Governments have different levels of legitimacy and connectivity with their population,” he said, citing as examples the current leadership in South Africa and Brazil, both of which have dramatically reduced poverty during the past decade. The South African government’s original 2.7 percent growth forecast for 2013 is unlikely to be met, he added.
In India -- swept by anti-corruption protests in 2011 -- Singh unveiled a program of food subsidies for the poor after growth slowed in the first quarter to the weakest since 2003.
The $21 billion-a-year effort adds to fiscal strains after the rupee touched a record low July 8, making it harder for the government, which is gearing up for elections next year, to boost infrastructure spending while cutting a deficit almost twice that of Greece as a share of GDP, according to IMF data.
China’s slowdown is being domestically engineered, as the government attempts to rein in speculative lending and real-estate prices. If the clean-up fails, jobs will be lost, adding to social tensions that are increasingly apparent online where dissent is widespread, said Nomura’s Newton.
The number of so-called mass incidents -- strikes, riots, protests and other disturbances to social order -- doubled to 180,000 a year in 2010 from 2006 levels, Tsinghua University sociologist Sun Liping wrote in 2010. The government no longer makes such figures public.
“What nobody knows is what it takes to get people tapping away on cyber space to go out on streets,” he said.
Other emerging markets should also be on the alert.
“When people are disappointed, they go to the streets,” said Michael Shaoul, chairman and chief executive officer in New York of Marketfield Asset Management, which oversees more than $11 billion. “They haven’t given that up just because they’ve had a good decade.”