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The Chrysalis Crisis

Butterflies metamorphose from eggs to larvae and then emerge from a chrysalis. Have emerging market butterflies stopped emerging?

A sucking sound can be heard as investors respond to the perfect storm enveloping emerging markets. On the one hand sovereign funds, asset managers and hedge funds are pulling the plug on their exposure. Meanwhile direct investors are shelving project plans, particularly in the energy sector.

Until recently the appetite of the Chinese economic dragon could not be assuaged. It stoked the commodity super cycle in emerging and resource-rich economies.

Quantitative easing, the developed world’s apparent salvation from the financial crash, unleashed a tsunami of cash boosting asset prices including equities and property at home. But QE’s synthetically depressed interest rates whetted investors’ risk appetite for higher yields among the exotic attractions of emerging markets.

Roll Reversal

But now the slowing rate at which steel is rolling off Chinese steel mills is desiccating the demand for commodities. In a quite unconnected reversal, Saudi Arabia opened the crude oil spigot to grab market share it was losing to US shale oil production and is likely to lose with the imminent re-entry of Iran to international oil sales.

Emerging markets face a quadruple-whammy. Firstly, falling commodity revenues. Secondly, sovereign wealth funds, mostly big commodity producers, facing sharply lower energy and raw material prices, are siphoning their money home to fill the fiscal sink holes appearing in their budgets. To top that low prices have led to the shelving of hundreds of billions of dollars for expanding energy and commodity infrastructure projects in resource-based economies.

The situation has become so precarious that the Bank for International Settlements (BIS) warns the BRICS (Brazil, Russia, India, China and South Africa) face debt service ratios that have traditionally signalled financial crisis.

But just when low interest rates from QE seemed to make debt servicing for emerging markets easy, the US Federal Reserve (perhaps prematurely) hiked interest rates, putting the dollar on steroids despite ambiguous evidence of economic recovery.

Sinking like BRICS, not flying like butterflies

The energy and the promise of emerging markets have ebbed from the high water mark of the “BRICS“ hyperbole.

But what do we call Argentina, Venezuela, Nigeria, Russia, Brazil and South Africa now? Will the clever analysts at global investment banks treat us to a new acronym – but what will they make of the jumble of SAVRNB, AVNRBS or VARBSN economies?

Emerging markets were eggs, full of promise. They developed into larvae but were thwarted in their emergence from the chrysalis as butterflies. Do they retreat, become unborn? They cannot be described by the antonyms for the word “emerging” as they will not “fade”, “disappear” or “go away”.

Instead these countries could emerge as “Chrysalis Economies”: not quite emerging but not fading into obscurity either. They can be dormant, wait, and take sanctuary from the high pressures of fledging until the climate is again right.

The chrysalis is also apposite not only because is it the stage where old larva tissues are broken down, an analogy for the corruption and over regulation in emerging markets; it is where the adult butterflies’ structures are formed that could be an allusion to sound governance, reliable infrastructure, predictable due process and renewed resilience.

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