Brutal financial markets

8 February, 2014
As appeared in

Malaysia had better beware…

WHILE markets may be uncertain about the real economy, they can be brutal about destroying value.

A Guardian columnist described a conclusion of cautious optimism at Davos last month this way: Cautiously optimistic and time will tell are just polite ways of saying “I haven’t got a clue.”

He was describing the state of uncertainty about the condition of the world economy. Short-term prospects for growth are good, especially for recovering advanced economies like the US and Britain. Yet it is not clear whether the recovery will be sustained. What is certain now is emerging economies are wobbly.

But why? Markets have found they are not so pretty after all. Only tarted up by US quantitative easing (QE). Excess money not then attracted to the home market it was supposed to be invested in found a home with dodgy people who apparently looked attractive in the dark.

Suddenly in the light of day introduced by the tapering of US QE you see, not what was wrong with you, but with those dolly-birds now with their make-up removed. A further reduction in QE from February to US$65bil has given the shivers reminiscent of the rush for the door that took place last May when Ben Bernanke first intimated the US Fed would scale back purchases of bonds from the then US$85bil a month.

You run. There is a run. The Argentine peso has been hit hard. The South African rand reached a five-year low. The Turkish lira, Russian ruble and the Indian rupee are all now very much weaker. Subsequent interest rate increases by Turkey, South Africa and India failed to stem the falls.

Will there be contagion? Shades of 1997? Who’s next?

There’s no recompense from Japanese QE, or the European Central Bank (ECB) easing policy to counter the threat of deflation. Or from the Bank of England, fumbling with “forward guidance” on when it will start looking at interest rate rises, which does not help even if the British economy shows promising signs of recovery, registering growth of close to 2% last year.

Really nothing can replace the size and certainty of American QE, unless it is the certainty of American economic growth. That potential growth now looks promising, although markets are uncertain.

How are emerging economies suddenly weak? This, markets now seem certain about. It all began when the US economy started to look good. And, of course, there is less money to play around with in those economies. What with glimmers of hope in the UK and Europe and Japan, emerging economies are really not that hot after all.

Don’t forget, China’s slowing down. When the figure came in of 7.7% growth last year against much lower expectation, it is of course suspect. Recent manufacturing numbers, anyway, do not look good. And remember, China has serious structural problems to address as well. The narrative must not be disturbed.

Thus, while there is no contagion (as yet?), there are causes of market distress specific to different emerging economies. Argentina: large current account deficit; meagre foreign currency reserves; domestic inflation about 25% (How I would want to get into that market in the first place, I don’t now know; all I know is I want to get out quick!)

Brazil and South Africa: signs of slowing (sic) Chinese economy and financial distress among shadow financial institutions (and China also has them, lurking to get into deep trouble any time now).

Russia: price of commodities driven by Chinese growth coming down (But not Australia?). Turkey and India: US QE tapering may deplete flows of liquidity necessary to finance current account deficits and short-term debt.

Quartz Daily Brief does an even better service by classifying emerging economies into several interesting categories: Serial political mismanagement (Venezuela, Argentina, Ukraine); Living beyond their means (Turkey, South Africa, Peru, Chile, Indonesia, Thailand) – which are also the most vulnerable to the US Fed QE taper; Fragile banking sectors (Hungary, Romania, Croatia); Domestic structural problems (Brazil, India, China, Russia which need to open up sectors run by the state, invest in infrastructure, stimulate domestic demand, fight inflation and corruption or improve financial systems).

Morgan Stanley now coins an alliterative grouping – the Fragile Five: Brazil, India, Indonesia, Turkey and South Africa. And so it goes on.

Malaysia, thankfully, has not been cast into any of the categories, although the ringgit has weakened against the dollar and the stock market is not looking too steady along with the rest of emerging markets.

However, the country seems to be straining at the leash to get into one of those holes. We must understand once the markets smell the blood of political trouble or fiscal laxity and indiscipline, we will be thrown to the wolves of Wall Street.

Never mind that markets themselves are no paragons of discipline. They have the power to sniff indiscipline and disorder, and to impose a cost on the country, which can be debilitating especially for a relatively small market and economy like Malaysia.

No point the country moaning about it. It is in the game. The central bank is doing an excellent job, but not the politicians who seem to have a death wish. The disorder that threatens the country over an emotional controversy on the use of the word “Allah” can cost the country dear.

Political trouble in Thailand has become par for the course, but if politically pristine Malaysia becomes unstable, financial markets will punish the country. Thailand knows how to deal with instability, Malaysia is not so well poised. Ironic, but we should not tempt the markets.

And then if there is a weakening of resolve as well to address the budget’s current account deficit in the face of opposition against the removal of subsidies, there will be hell to pay in terms of the future of the country’s economy, currency, financial and capital markets.

While Malaysia has to manage price increases, it cannot avoid them if it wants to address the fiscal deficit. Unfortunately, too many decisions on revenue and expenditure were put off for the longest time. Something has to be done now, even if the present government has to bear the brunt. It has to carry out its responsibility if the country’s economy is to avoid severe damage.

In 1997-98, the Indonesian GDP came down by 13% to 14%. More recently in the euro crisis, Greece lost 23%. Most of all, this means unemployment shooting up with miserable social and economic outcomes.

This existential threat must be understood and communicated in a clear and simple manner so that the people can appreciate the risks the country faces if it does not hold together to address political and fiscal issues.

Indeed word is out in financial markets Asean faces in 2014 an outlook clouded by political risks. Already GDP growth has been marked down from 5% last year to no more than 4.7% in 2014. With political trouble in Thailand, elections coming up in Indonesia, Malaysia as the region’s third largest economy should not want to add to these political risks.

The bottom line is whatever the economic prospects of the real economy, if market forces sense trouble of any kind that is not liked, those prospects will never be realised. The real economy will be pulled down by the destruction of value of financial assets that will put it at the starting line again.