What Are the Fragile Five?

Five Emerging Markets Overly Dependent on Foreign Investment

Flower market in Bangalore, India
Flower market in Bangalore, India. Peter Adams/Photographer's Choice/Getty Images

It's no secret that financial analysts have a love of acronyms, whether they're referring to PE ratios or EBITDA. The most well-known acronym among international investors is Goldman Sach's Jim O'Neill's BRICs, which represents the four largest emerging market economies - Brazil, Russia, India, and China. But, there are many other acronyms that have gained prominence and can help investors. 

In this article, we will take a closer look at the Fragile Five and where these economies may be headed over the coming years.

What Are the Fragile Five?

Fragile Five is a term coined in August of 2013 by a financial analyst at Morgan Stanley to represent emerging market economies that have become too dependent on unreliable foreign investment to finance their growth ambitions. The acronym follows a long line of analyst acronyms that have caught on over the years, including Jim O'Neill's BRICS and MINTS acronyms.

As capital flows out of emerging markets to developed markets, many of their currencies experienced significant weakness and made it difficult to finance current account deficits. The lack of new investment also made it impossible to finance many growth projects, which contributed to a slowdown in their respective economies. This created a potential issue for certain vulnerable economies.

The five members of the Fragile Five include:

Capital Flows in 2013 & 2014

The term Fragile Five was coined in response to the global economic recovery between 2011 and 2014.

After many developed economies contracted in 2008, emerging market economies attracted a large amount of investment capital due to their relatively strong growth rates. This capital was employed in various parts of the economy to enhance growth rates. For example, new infrastructure projects were taken on that employed a number of citizens and companies in the region.

The subsequent recovery in developed markets drew a lot of this capital back home and resulted in less foreign direct investment in emerging markets. Developed economies, like that of the United States, posted strong returns throughout 2013. The U.S. Federal Reserve also decided to taper its bond-buying program and raise interest rates, which resulted in a stronger U.S. currency relative to emerging market currencies. These dynamics led an increasing number of investors to sell emerging market currencies and move into USDs.

The term has since been expanded to the Troubled Ten as the United States interest rate hike schedule has caused concerns among slowing emerging markets.

Fragile Five Cracks Appear

In early 2014, Argentina revalued its currency sharply lower in response to unsustainable domestic policies and high rates of inflation. The country sold more than 8% of its foreign reserves during January of 2014 prompting the central bank's capital to reach their lowest levels since October of 2006. While Argentina is not a member of the Fragile Five, their decline prompted the emerging market sell off that occurred just after the fall. As investors began selling emerging market currencies and moving into U.S. dollars, partially in response to the U.S. Federal Reserve tapering, emerging market currencies began losing value and investment capital began leaving.

Fragile Five markets like Turkey responded by dramatically hiking its interest rates at an emergency midnight policy meeting in order to defend its currency but the move has done little to quell the issue. Fragile Five countries like Turkey have relied on foreign investment to replenish their current account deficits. Rising interest rates could also have a number of negative effects on susceptible emerging market economies. For example, higher interest rates raise the debt burden for loans and could lead to a contraction in commercial bank margins. These dynamics could further depress economic growth by removing capital.

Where the Fragile Five Are Headed

The Fragile Five surfaced in 2013 and experienced a shock in 2014. In 2015, these markets experienced ongoing declines as capital flows out of emerging markets and into developed markets.

Morgan Stanley analysts expanded the Fragile Five to the Troubled Ten in mid-2015 in response to the sell-off moving beyond these five countries and into other key emerging markets.

The Troubled Ten economies include:

Several members of the Fragile Five were omitted from this list as their economies have either already experienced losses or gained traction. For instance, India's economy has remained fairly robust despite the global meltdown in emerging markets throughout 2014 and 2015. The remaining four countries were the worst performers between August of 2013 and August of 2015.

Key Takeaway Points

  • Fragile Five is a term coined in August of 2013 by a research analyst at Morgan Stanley to represent emerging market economies that have become too dependent on unreliable foreign investment to finance their growth ambitions.
  • The Fragile Five include Turkey, Brazil, India, South Africa, and Indonesia.
  • The Fragile Five came into focus in 2013 and 2014 as emerging market economies that relied on foreign investments to cover current account deficits and finance growth began to see capital outflows as a result of improvements in developed economies.