Emerging Countries: Hot Summer Ahead?

Protest movements in Turkey and Brazil, a squeeze on bank liquidity in China, capital outflows and drop in equity and commodity prices: emerging countries are in the midst of a difficult period. Following the “Arab Spring” of 2011-2012, some claim we are at the beginning of an “Emerging Summer”. Yet the pressures at work have very diverse origins or are less profound than those that led to the downfall of regimes in Tunisia and Egypt.

Two years after the Arab Spring and in the midst of a growth slowdown, are we about to witness an “Emerging Economies Summer”. This question is raised by Turkish and Brazilian protest movements. Yet the similitude of the two situations stops at the spontaneous and popular nature of the protests. The protests in Brazil and Turkey lack the depth and scope of the uprisings in Tunisia and Egypt, the goal of which was to overthrow the ruling presidents. Moreover, in Brazil and Turkey, the reasons behind the protests are both heterogeneous and diversely shared by different segments of the population.

In Turkey, protesters denounced the violation of individual freedoms as well as the government’s slide into authoritarianism. They explicitly demanded the resignation of Prime Minister Erdogan. Yet their demands are far from being shared by the AKP’s supporters, who continue to back the prime minister. In brief, although aspirations run deep, the protesters’ base is narrow.

In Brazil, the reverse is true. Dilma Rousseff’s legitimacy has not been called into question, even though corruption among the political class is a major reason of discontent. Their demands are mainly economic, reflecting a state of exasperation, but not a thirst for freedoms. In contrast, the protest movement has a very broad base, including the working and lower-middle classes. As a result, unlike Turkey, the Brazilian situation seems to carry more risk of spinning out of control if the government does not respond to expectations. Moreover, Brazil is still a violent society with one of the world’s highest murder rates.

The discrepancy between Turkey and Brazil explains why the reactions of the two heads of state have been so different. In Turkey, Mr Erdogan has shown proof of great firmness. Granted, he agreed to meet with the opponents of a planned redevelopment project at Taksim Square, where the protests originated, along with a few NGO representatives. Yet his only commitment was to follow the ruling of the Istanbul Court that suspended construction, and if the project is upheld, to hold a referendum with the people of Istanbul. In Brazil, in contrast, the movement surprised and destabilised Dilma Rousseff. The president was rather quick to acknowledge the legitimacy of the protesters’ demands for better public services, and opened tripartite discussions between the central government, regional governors and protest leaders. To address the problem of corruption, she also proposed reforming the constitution to modify the proportional voting system and financing of political campaigns.

It is difficult to assess the reaction of investors to these street protests since recent capital outflows have also coincided with the Fed’s announcement of a reduction in quantitative easing. Moreover, given the size of portfolio investments in Brazil and Turkey (10% and 16% of GDP, respectively), interest rate, exchange rate and equity price movements are particularly sharp during periods of stress. Since the end of April, the Brazilian real and the Turkish pound have depreciated by 10% and 8%, respectively, against the US dollar, compared to an average 6% decline for the emerging markets with the highest exposure to portfolio investments. EMBI+ spreads (risk premium on sovereign debt in USD) widened by 82bp in Brazil and 71bp in Turkey compared to 63bp for a set of investment grade counterparties. Lastly, equity prices have fallen 18% in both countries compared to 10% for the MSCI index (in local currency). If these variations are considered to reflect the relative increase in political and social risks, then investor mistrust of Brazil is slightly higher than that of Turkey.

In China, the central bank (PBOC) initially seemed to remain inflexible in the face of the strong rise in interbank rates in June. Liquidity tightening has resulted from a decline in supply (capital outflows) and stronger demand due to seasonal factors and to the arrival at maturity of some Wealth Management Products (WMP). Usually, under such circumstances, the banks rely on the PBOC to inject liquidity. This time, the authorities chose not to intervene at first, a move designed to control WMP activity, and in general, to tighten monetary conditions following the upturn in credit in the first months of 2013. This firm stance is commendable but risky, since it increases liquidity risks in the interbank market and could trigger an abrupt correction of domestic credit. Let us hope that China will make use of its room for manoeuvre (abundant liquidity, high reserve requirement ratios) to contain risks of financial instability. The PBOC has already backpedalled, assisting certain banks after stress levels peaked on 24 June.

BY Christine PELTIER , François FAURE