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Analysis & opinionJanuary 5 2015

Reform needed in 2015

Genuine economic reforms will be vital to offset growing volatility in emerging markets.
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The 2015 outlook is for risk to return to emerging markets. For several years, leading emerging markets looked more stable than developed countries with stronger financial systems, growing economies and improving business and political environments.

But now the tide is turning. Yields on emerging market bonds have at times overshot themselves and were a reflection more of US quantitative easing (QE) than real risk.

With US rates set to rise in 2015, emerging markets may blame the fallout on US monetary policy but this only tells half the story. The failure to reform during the boom period is a much more significant factor.

In this context Brazil is the classic case. The country ranks a poor 120th in the World Bank’s Ease of Doing Business rankings and failed to take advantage of benign economic conditions to reform its bureaucracy and renew its infrastructure. The fall in the value of the real is as much about taking account of this as it is about the US unwinding of QE.

Russia has failed to diversify its economy away from dependence on oil and its focus has been too much on foreign policy and not enough on domestic reform (see accompanying editorial).

China by contrast is definitely reform minded but whether it can achieve all it needs to while at the same time tightening rather than loosening central political control is questionable. China’s policy-makers have a great track record but they cannot expect to be right about everything all the time. Greater devolution of power to individuals and markets would act as a counterweight for mistakes.

All three countries – Brazil, Russia and China – start out with strong banking systems, which gives them an advantage if there are rocky times ahead. All the same, their risk managers will need to stay very alert. 

Among the BRICs the exception in 2015 is likely to be India. India starts out from a weak position – a position of 142 in the World Bank’s Ease of Doing Business rankings. Its currency has also been under pressure due to external factors. But this will be limited as long as prime minister Narendra Modi can convince markets that he is serious about reform and is able to deliver. On this basis India will likely perform better in 2015 than the other BRICs.

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