How important are the Fragile Five?

This article is part of
Global Emerging Markets - March 2014

The Fragile Five is the latest acronym to hit the emerging markets, with concerns regarding the effect of US tapering heightened by the apparent current account deficits of the countries in question – Brazil, India, Indonesia, South Africa and Turkey.

But is the singling out of these countries from all emerging markets simply a warning of the excesses of those countries that relied too heavily on loose monetary policy in the west, or an overreaction?

Jan Dehn, head of research at Ashmore, argues that the situation could soon turn towards calling them the ‘frugal five’, as they were basically “more of an excuse for selling emerging markets last year, than a really good reason”.

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“What these five countries had in common was they had some macroeconomic adjustments to do, but there is a big difference between a macroeconomic adjustment and a crisis.

“The market quickly labelled them the fragile five, basically portraying them as countries with genuine serious crises, but they never were. Countries go through these macroeconomic adjustments all the time whether they’re in emerging markets or not.”

He points out that India, a core emerging market and member of the Brics, has a growth rate that never fell below 4.5 per cent in 2013, and with reserves of more than $250bn (£150bn), a sustainable debt burden, a healthy banking system and corporate sector, the issue is difficult to see.

“The only problem it had,” explains Mr Dehn, “is that domestic demand got a little overheated. As a consequence it started importing too many goods and created a trade deficit. But we know how these problems are solved, you basically reduce domestic demand by raising taxes, cutting spending or raising interest rates and then you adjust your currency a little bit and that restores your external equilibrium.”

While he acknowledges this was the common factor among the ‘fragile five’, Mr Dehn emphasises the necessary adjustments required are a long way from the crisis that hit emerging markets in the 1990s.

“There are crisis prone economies in the emerging markets, but they are not the fragile five. The ones that spring to mind are Argentina, Venezuela and Ukraine. These three countries, in particular for mainly domestic political reasons, are almost permanently surfing on the edge of a macroeconomic crisis, but the markets have understood these three countries are special and that nothing to do with tapering has an impact on these.

“The bottom line is that the fragile five are not nearly as fragile as their title would suggest.”

Paul Rogers, manager of the Lazard Emerging Markets Core Equity fund, agrees that the ‘fragile five’ is “not a useful moniker”.

“It is important to point out that equity market returns and the GDP of countries are not correlated. We’ve been able to make good money in both South Africa and Turkey over time, and we think they are the two weakest countries. But if you look at the statistics, the reserve situation in countries like Brazil, India and even Turkey is not bad. There is relatively strong foreign direct investment, particularly in Brazil and India and in Indonesia the current account deficit to GDP is less than 3 per cent.”