What Are the Troubled Ten?
Morgan Stanley's 10 Economies at Risk from China
Morgan Stanley coined the term “Fragile Five” back in August of 2013 to represent five emerging market economies that have become too dependent on unreliable foreign investment to finance their growth plans – Turkey, Brazil, India, and South Africa. Since then, these countries have been among the world’s weight worst performing currencies due to rising global interest rates that make it more difficult to finance current-account deficits.
After China’s surprise devaluation of the yuan in mid-2015, Morgan Stanley analysts highlighted ten additional countries that could be facing troubles ahead. Bloomberg has coined these the “Troubled Ten” and they include Colombia, Chile, Peru, South Korea, Thailand, Russia, Singapore, Taiwan, Brazil, and South Africa. These countries have the highest export exposure and export competitiveness with China and could be the most vulnerable to a currency war.
In this article, we will look at the so-called troubled ten and whether international investors should avoid these countries.
China represents the top export destination for most of the Troubled Ten economies, including nearly 40% of South Africa’s exports and 30% of South Korea’s exports in 2014. With Chinese authorities taking drastic measures to spur economic growth, including interventions in the equity market, lower interest rates, and currency devaluations, there is a growing concern that the country’s economic turmoil may be more serious than many economists expected.
Many of the Troubled Ten also exports the same goods as China to foreign customers around the world. With the sharply lower yuan valuation, Chinese goods will become cheaper for these customers and put pressure on the Troubled Ten to either devalue their own currencies or risk slowing exports and economic growth. These dynamics could lead to an emerging market currency war that’s already taking place in places like Kazakhstan.
The good news is that many of these risks have been mitigated moving into the 2017. China's economy has been experiencing better-than-expected growth and concerns over its shadow banking sector have been cooled by higher lending standards. However, there are several key risks that still exist and investors should remain cognizant of the country's performance and measures to promote stable growth.
The Troubled Ten may also be facing many of the risks seen by the Fragile Five back in 2013, as developed markets look to raise interest rates. With the Federal Reserve hiking rates, capital could be lured away from emerging markets at a faster clip, as U.S. dollars become more attractive on a global level. Many emerging markets are ill-prepared for these changes given their reliance on foreign investment for growth.
The sharp drop in commodities has also put pressure on many of the Troubled Ten that have above-average exposure. For instance, Peru is the world’s largest exporter of copper, with copper prices falling nearly 20% between January and August of 2015 alone. Investment in the country has fallen along with the commodity’s price given the lesser expectation of profit, which has put pressure on the country’s currency and economy.
The good news is that the Federal Reserves pace of increasing interest rates has been relatively slow, which has given these economies time to adapt. At the same time, China's growing economy has supported commodity prices moving into 2017 and beyond. The move by the European Central Bank (ECB) to unwind its fiscal stimulus programs, however, could lead to weakened emerging market currencies in the latter half of 2017 and 2018.
The Troubled Ten face a lot of economic headwinds over the coming quarters, as they struggle to compete and sell to China, as well as with a potential economic slowdown. As a result, international investors may want to exercise caution when investing in these ten economies, while perhaps hedging any existing exposure that they have to them with stock options, index options, currency hedges, commodity hedges, or other similar measures.
Key Takeaway Points
- Morgan Stanley’s Fragile Five has been expanded to the Troubled Ten following China’s surprise devaluation of the yuan and its implications on the global economy.
- The Troubled Ten are characterized by their export exposure to China and the potential problems associated with capital flight following higher interest rates in the U.S.
- International investors may want to steer clear of these currencies and economies until the economic picture becomes clearer over the coming years.