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Business Comment

Satyajit Das: Trophy projects and debt hindering Brazil and other emerging markets


Slowing growth and the withdrawal of foreign capital is now exposing deep-seated problems in emerging markets.

Debt levels in emerging markets have risen significantly, with total credit growth since 2008 in the range of 10 to 30 per cent depending on country. Credit growth has been especially strong in Asia. Total debt to gross domestic product (GDP) above 150 to 200 per cent of GDP is now common. Credit intensity has also increased sharply. New credit needed to generate each extra dollar of GDP has doubled to about $4-8 for each dollar of GDP growth.

Bank credit has increased rapidly and is above the levels of 1997 (as percentage of GDP) in most countries.  There has also been rapid growth in debt securities issued by emerging market borrowers, in both local and foreign currencies.

Borrowing varies between sectors, depending on country. Consumer credit has grown strongly in many Asian countries and also in Brazil. Many corporations in China, South Korea, India and Brazil are highly leveraged. Combined gross debts at India’s biggest 10 industrial conglomerates having risen 15 per cent in the past year to $102bn (363bn). Many borrowers are over-extended with inadequate cash flow to meet interest and principal payments, especially in a weak economic environment.

With notable exceptions like China and India, government debt levels are not high. However, state involvement in banks and industry mean that effective level of government obligations is higher than stated.

Sustainable levels of public debt are lower for emerging market countries, given lower per capita income and wealth.

Banks and investors with exposure to emerging markets are at significant risk. Borrowing has been used, worryingly, to finance consumption, investment in infrastructure projects with uncertain rates of return or speculation.

In many emerging countries, quasi-government bank officials have financed projects sponsored by politically connected businesses and elites. Lending practices have been weak, helping finance expensive property and grand vanity projects with dubious economics.

Many borrowers will struggle to repay the debt. The current account surplus of emerging market countries has fallen to 1 per cent of combined GDP, from about 5 per cent in 2006. The deterioration is greater, as large trade surpluses of China and energy exporters distort the overall result. The falls reflect slow growth in export markets, lower commodity prices, higher food and energy import costs and domestic consumption driven by excessive credit growth.

India, Brazil, South Africa and Turkey have large current account deficits, which must be financed overseas. India has a current account deficit of about 6 to 7 per cent and a budget deficit (Federal and State government) approaching 10 per cent which requires funding. Countries dependent on commodity exports are also vulnerable, given the fall in prices and anaemic global economic growth.

Emerging countries require about $1.5 trillion per annum in external funding to meet financing needs, including maturing debt. A deteriorating financing environment combined with falling currency reserves, reduced cover for imports and short-term borrowings, declining currencies and diminished economic prospects have increased their vulnerability.

The difficult external environment has highlighted long-standing structural weaknesses.

Investors fear that many emerging markets may be caught in a middle-class income trap, where countries experience a sharp slowdown in economic growth when GDP per capita reaches about $15,000.

Emerging economics remain highly linked to developed economies, through trade, need for development capital and the investment of foreign exchange reserves. Weak growth in developed markets and decreasing credit quality of developed country sovereign bonds may adversely affect emerging markets. Emerging countries have also lost competitiveness, as a result of rising costs, especially labour.

Investors are concerned about mal and mis investment. Trophy projects, such as the 2008 Beijing Olympics (costing $40bn), Russia’s 2014 Sochi Winter Olympics ($51bn) and Brazil’s 2014 football World Cup, have absorbed scarce resources at the expense of essential infrastructure.

Income inequality, corruption, hostile and difficult business environments, excessive concentration of economic power in heavily subsidized state corporations and political rigidities increasingly compound the problems of debt and capital outflows. Political instability exacerbates economic problems, for example in Brazil, Turkey, South Africa and India.

These concerns have resulted in a new acronym for the more vulnerable emerging markets – Biits (Brazil, India, Indonesia, Turkey, South Africa). It seems the Brics are now breaking into Biits.

Satyajit Das is a former banker and author of ‘Extreme Money’ and ‘Traders, Guns & Money’