Brazil And South Africa: Could Turmoil Lead To Default? by [email protected]

Franklin Allen on the risks facing Brazil and South Africa

The economic slowdown in China has taken an economic toll on supplier countries – particularly emerging markets – that provide raw materials and other inputs. Some analysts say it is a key reason why investors are now worried that Brazil and South Africa could default on loans. But Wharton finance professor Franklin Allen says he does not expect either country to default. And while the slowdown in China has certainly led to weaker demand for such commodity exporters, “I think particularly Brazil — but also to some extent South Africa — has many additional problems” – notably, corruption.

In this Knowledge in 5 interview – the second in a three-part series (see part one here) — Allen points out that currency and credit markets will continue to provide the best indicators of the economic health for the two countries. More generally, he also sees a “significant, [although] maybe not a major, probability” of a global financial crisis of some kind as a result the slowing global economy and adjustment problems that may crop up when the U.S. Federal reserve starts raising interest rates – most likely by year end.

Meanwhile, Christine Lagarde, head of the International Monetary Fund, noted this week that emerging market countries (and bond markets) expect rising corporate bankruptcies when the Fed finally starts to move up interests rates. The IMF has counseled the Fed to hold increases off until 2016. At the same time, the Institute of International Finance, a trade group, announced that emerging markets saw the largest divestment of assets since 2008 – some $40 billion worth – during the third quarter.

An edited transcript follows.

[email protected]: Brazil might be exhibit “A” for how emerging markets are being affected by China and a general global economic slowdown. Its currency is down more than 30% this year against the dollar. Investors are increasingly betting that Brazil and also South Africa might default on their debts. The South African rand is down about 15%. It used to be thought that emerging markets would be the new economic locomotive, pulling other economies along, perhaps as the U.S. has for decades. What do you think is going on?

“I don’t think it is likely that [Brazil and South Africa] will default, but it is certainly now a possibility … [that] investors are worried about, so they are pulling the money out now.”

Franklin Allen: I think particularly Brazil — but also to some extent South Africa also — has many additional problems on top of those problems that we have been discussing [See: “The China Syndrome — How Volatility Is Affecting ASEAN”].

In Brazil, there is the issue of the corruption. There is the problem that the finance minister, who was expected to get the finances in order and be very tough, does not seem to have full support in the cabinet. The president [Dilma Rousseff] is very weak — her approval ratings are down to 8%, I believe, which is one of the lowest scores seen in any country.

They are supposed to have financial transactions taxed to plug a hole in the deficits, but she did not get that through, so now they are looking at a deficit of 8% to 10% — that kind of number. This is within a country with quite high debt levels, I believe 60% to 70% … in a year’s time if they do not plug the gap. And they are paying 7% real rates of interest on much of this debt. It is quite an unstable situation. I don’t think it is likely that they will default, but it is certainly now a possibility, and I think that is something that investors are worried about, so they are pulling the money out now, and things are not good there.

See full article here.

Brazilian ETF