"Happy families are all alike," Leo Tolstoy observes at the start of Anna Karenina, but "every unhappy family is unhappy in its own way." The same could be said about several of the emerging markets these days. From Turkey to Argentina and Brazil to South Africa, the turmoil still looks more like a collection of individual countries getting into trouble than the beginning of a lasting emerging-market downturn.
"The majority of emerging-market economies has become much more robust to external shocks in recent years," argues Elke Speidel-Walz, Chief Economist Emerging Markets at DWS, before ticking off all the ways in which this time might indeed be different: "Since the crises of the 1990s, prudent fiscal policy has become a policy priority in most countries. Flexible currencies should help as shock absorbers. Current-account deficits are much lower than in the past. Central banks mostly appear to have inflation under control and to have earned credibility in financial markets."
Only two of the 20 most important emerging-market countries run a current-account deficit of significantly more than 3% of gross domestic product (GDP). Those two are Turkey and Argentina. Indeed, Turkey's crisis does look country-specific and unique. In recent years, Turkey had embarked on an unsustainable growth model. In 2017, GDP grew by 7.5%, largely as a result of large-scale policy stimulus, such as minimum-wage and welfare-benefit increases. This helped fuel private consumption. Predictably, it has also led to an overheated economy with sharply accelerating inflation.
To make matters worse, Turkey has long relied on foreign short-term capital inflows to finance its profligate ways. A current-account deficit is just another way of measuring the amount by which domestic savings fall short of domestic demand, notably for corporate investment. In Turkey's case, the corporate sector has seen rapidly rising debt levels, increasingly borrowing in foreign currencies, mostly dollars. When its currency came under pressure, the burden of its dollar-dominated debt kept rising, just as the domestic outlook for revenues and profits kept darkening. The absence of adequate economic-policy responses further fueled investor fears. The room for maneuver of Turkey's once widely respected central bank had already been curtailed in the run-up to the June presidential and parliamentary elections. Its belated decision to raise rates in September only partially restored its credibility.
At the first glance, Turkey's troubles look like the sad culmination of known weaknesses and unforced errors. Argentina has been doing rather better on the policy front. It also has high fiscal and current-account deficits, high external short-term debt and very high inflation. But its market-friendly government had already enlisted help from the International Monetary Fund. It committed to a wide range of painful policy measures. The reason for the currency selloff is that financial markets increasingly doubt reformers can win a popular mandate in the elections, due to be held in October 2019.
Other countries lately under market scrutiny include Brazil and South Africa. Fundamentally, both look rather more solid, though recent economic growth rates have been disappointing, hinting at structural weaknesses. In Brazil's case, the main problem has been government spending growing at a much faster pace than tax revenues. Attempts by the outgoing president to trim its unsustainably costly pension system failed earlier on this year. Following widespread corruption scandals, Brazil's political landscape looks set to become even more fragmented after October's general elections. South Africa has bigger structural problems, a comparatively high current-account deficit but also a new president willing to tackle its structural problems. Unfortunately, the task was not made any easier when U.S. President Donald Trump decided to intervene in the contentious issue of South African land reform via Twitter.
Which brings us back to Anna Karenina. At the heart of Tolstoy's novel is a story of love – and betrayal. The immediate trigger of the collapse in the Turkish lira was the U.S. decision to double the tariffs on steel and aluminum from Turkey, in protest of the continuing imprisonment of American Pastor Brunson. Not so long ago, such a measure would have been unthinkable. Since the protectionist days of the 1930s, Western democracies have rightly and wisely been reluctant to use trade sanctions in order to further geopolitical goals. Turkey, after all, has been a traditional ally.
Part of the reason that most emerging markets entered recent turbulences in relatively solid shape is that they have been following a set of macro- and microeconomic policies that used to be known as the Washington consensus. Typically, emerging-market policies over the past two decades have included steps to free up markets, as well as commitments to free trade and sound monetary and fiscal policies. To turn recent turbulences into a lasting crisis would probably require a wholesale repudiation of these principles. That still looks unlikely but not as unthinkable as it once was. What happens in Washington will continue to reverberate. One drag on emerging markets has been the strength of the dollar, partly driven by last year's deficit-financed U.S. tax cuts and spending increases. A stronger dollar and rising U.S. interest rates at the end of this long cycle have always been likely to present some challenges to emerging markets. But matters have been made worse by market-rattling U.S. trade policies.
Generally, foreign capital inflows have financed long-term, growth-enhancing investments in emerging markets rather than consumption.
Sources: Deutsche Bank AG, DWS Investment GmbH as of 09/2018
* e = expected
In recent years, some emerging markets have seen rapid growth in foreign-currency-denominated debt, mostly as a result of corporate borrowing.
Sources: The Institute of International Finance Inc., Bank for International Settlements, DWS Investment GmbH as of Q1/2018