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The Fragile Five

By Mudit Dugar

10 years ago, Goldman Sachs declared Brazil, Russia, India and China (BRIC) as the emerging markets with the brightest economic growth prospects.

Morgan Stanley declared the Brazilian real, the Indonesian rupiah, the South African rand, the Indian rupee, and the Turkish lira as the “Fragile Five,” or the troubled emerging market currencies under the most pressure against the U.S. dollar. The phrase “Fragile Five” seems to have been first coined by Morgan Stanley analyst James Lord in August 2013. Since then, the phrase has gained increasing traction as a catchall for the most concerning emerging market economies – which together represent around 7 percent of the world’s economy.

“High inflation, weakening growth, large external deficits, and in some cases exposure to the China slowdown, and high dependence on fixed income inflows leave these currencies vulnerable,” wrote Morgan Stanley analysts in an August research note.

Forget the BRICS: what’s really concerning investors now are the “Fragile Five”.

As the cost of employing workers in these countries has risen, there has been less investment from foreign companies, fewer exports and slower economic growth. This has hit those countries’ balance of payments – which measures the balance of a country’s transactions with the rest of the world. If a country’s exports, including financial transactions, are less than its imports it runs a current account deficit.

Coupled with relatively weak economic growth in the Fragile Five, these current account deficits are causing alarm among investors.

Add elections in four of the five countries, and there’s further cause for concern.

The Fragile Five’s currencies saw a massive sell-off when it looked as though the U.S. Federal Reserve was going to gradually wind down its bond-buying program known as quantitative easing. As QE meant more readily available cash for investors, emerging markets have been benefiting with increased investment. But worries about the Fed “taper” to the QE program led to currency traders pulling their money out.


Now let us look at a country wise analysis –

Brazil real

The real is down over 15% against the USD in the past year. Brazil has a current account deficit of 3.59% of GDP.

Speaking in London, Brazil’s central bank president Alexandre Tombini said policymakers would fight inflation in a statement that was more hawkish than some had expected. The central bank has already raised its Selic rate seven consecutive times to 10.5% to clamp down on inflation.

“The Brazilian response has been very classic – tightening policy, using foreign reserves as buffers,” Tombini told the Financial Times. “Other countries will have to follow suit . . . some may be reluctant.”

Brazil saw presidential, general and local elections in the fourth quarter of 2013.

Indian rupee

The rupee is down some 14% against the USD in the past year. India has a current account deficit of 4.37% of GDP.

India’s wholesale price inflation has been cooling but the slowdown in food prices could be temporary. Meanwhile, consumer prices are still high at 9.87%. WPI doesn’t factor in the cost of services and because it accounts for prices at the wholesale level it doesn’t measure prices as they trickle down to the consumer.

But the downward trend in inflation does give the Reserve Bank of India room to keep interest rates on hold, even as the government tries to curb expenditures, in an election year, as it tries to rein in its fiscal deficit.

India sees general elections in May. There is some concern that no matter which party is voted into power, it will have to form a coalition with smaller parties and some states will continue to be controlled by opposition parties and that too could stall reform.

Indonesian rupiah

The rupiah was the worst performing emerging market currency in 2013 and is down 21% against the USD in the past year. Indonesia has a current account deficit of 3.71% of GDP.

Some expect that the rupiah will strengthen in the second half of this year after its presidential elections on July 9. The country has seen some unrest following fuel price hikes.

The central bank kept its key rate unchanged in January after raising it 175 basis points since early June. While Indonesia is worried about its current account deficit, it is unlikely to raise rates on account of inflation, which it expects, will ease to its target range this year.

Turkish lira

The lira is down 24% against the USD in the past year. Turkey has a current account deficit of 7.22% of GDP.

The lira has been getting punished on the back of a corruption scandal threatening Prime Minister Tayyip Erdogan and the ruling AKP party. But Turkey also has a current account deficit and unsustainable construction fuelled economic growth.

The central bank has called for an emergency meeting and some are anticipating that it will raise rates to help bolster the currency. But economists warn that any reprieve could be temporary.

Turkey sees municipal elections in March and a presidential election in August.

South African rand

The rand is down over 19% against the USD in the past year. South Africa has a current account deficit of 6.8% of GDP.

Like the other countries on this list the rand is weighed down by South Africa’s current account deficit (CAD) and a rising real effective exchange rate (REER), which is expected to worsen CAD concerns.

The rand is also more vulnerable to a slowdown in China and the impact that it could have on commodity prices, specifically industrial metals. In South Africa, we saw wildcat protests to raise the wages of the lowest-paid miners so they were growing faster than inflation.

South Africa has notoriously kept its interest rate unchanged since July 2012.

To conclude with, below are some graphs, which have been accumulated from various sources. Hey show a graphical representation of the dwindling economies of the ‘Fragile Five’ countries.

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