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Brazil and Indonesia: A Study in Contrasts of Emerging Markets

Scandal and limited policy room leave Brazil among the more vulnerable EM economies, whereas Indonesia manages to sustain growth.

Emerging-markets economies around the world face growing pressures from tighter global liquidity and a growth slowdown in China, but no two EM countries are alike. Consider the cases of Brazil and Indonesia.

Brazil’s deep recession and burgeoning political corruption scandal make it one of the most vulnerable emerging-markets countries, bankers and policymakers agreed last weekend at the annual meetings of the International Monetary Fund and World Bank in Lima, Peru. The country has no room to ease fiscal or monetary policy because of a yawning budget deficit and high inflation, and the government has failed to pursue structural reforms in recent years, which is one reason why the economy is performing so poorly. Indonesia, by contrast, is managing to sustain solid growth despite its close proximity to and interconnection with the Chinese economy.

“We learned the best defense [is] if you are healthy,” Perry Warjiyo, deputy governor of Bank Indonesia, said in an interview at the IMF meetings. The central bank hiked rates earlier, in 2013, to bring inflation under control; tougher banking supervision adopted in the wake of the 1997–’98 Asian crisis has created a healthy banking sector with an average capital ratio of just over 20 percent; and government moves to eliminate gasoline subsidies to help finance increased infrastructure spending are fostering growth. The economy is expected to expand by 4.7 percent this year and 5.1 percent in 2016, according to the IMF.

The contrasting fortunes of the two countries offer lessons for other emerging-markets economies struggling in today’s harsh global environment. China’s slowdown has taken away the biggest growth driver of many EM economies. The country’s imports plunged by 17.7 percent in September from a year earlier, the 11th consecutive monthly drop. That slowdown, combined with anticipation of rate hikes from the Federal Reserve Board, has caused capital to flow out of emerging markets for the first time in more than a generation. The Institute of International Finance (IIF), a trade body, predicted last week that foreign investors would withdraw a net $541 billion in capital from 30 leading EM economies this year, the first such withdrawal since 1988, and it predicted outflows would continue, albeit at a more moderate pace, in 2016.

Few countries have been hit as hard as Brazil. The country has long been one of the biggest magnets for foreign capital in the EM universe because of its open and deep capital markets, but the fallout from lower commodity prices and a scandal over multibillion-dollar kickbacks from state-owned company Petróleo Brasileiro has sent the economy into a tailspin. Economic output is expected to contract by 3 percent this year and 1 percent the next, while inflation is seen hitting 8.9 percent this year before easing, according to IMF projections. The Fund’s managing director, Christine Lagarde, underscored the problem by lumping Brazil with Venezuela as the two Latin American countries struggling the most to adjust to today’s weak global economy.

President Dilma Rousseff is seeking to restore confidence by backing the efforts of her Finance minister, Joaquim Levy, to contain a big budget deficit, but the threat of impeachment proceedings against the president over the Petrobras affair has emboldened congressional opponents of austerity.

“The core of the issue in Brazil is fiscal,” Ilan Goldfajn, chief economist of Itaú Unibanco, Brazil’s second-largest bank, by assets, told a panel session organized by the IIF. “You really don’t have the space that other countries have for countercyclical policies.” The fact that Rousseff’s popularity rating has plunged into single digits “makes it very difficult to approve the fiscal measures that you need,” he added.

Levy, interviewed on the sidelines of the IMF meetings, vowed to push for greater fiscal restraint, despite opposition in Congress. “It’s clear what we need to do,” he said. “There are not many alternatives.” He faces a big uphill struggle. The government recently admitted that it would miss its target of achieving a primary budget surplus (the balance before taking into account debt interest) next year, and Congress so far is blocking Levy’s proposal for a financial transactions tax to help close the gap. Those factors led Standard & Poor’s Ratings Service to remove Brazil’s investment-grade rating last month, downgrading the country by one notch, to BB+.

The economy will respond “sooner than you think” to the adoption of a credible fiscal policy, Levy said. But even in the absence of a fiscal breakthrough, he said, Brazil had “a lot of flexibility to respond to changes in China.” The most important one, Levy said, was allowing the real to depreciate to improve the competitiveness of Brazilian exports. The real has fallen by just over 40 percent during the past 12 months, to trade at about 3.87 to the dollar.

In Indonesia, meanwhile, the fallout from slower growth in China “has been more than what we had expected,” by dampening demand for coal and other commodity exports, Finance minister Bambang Brodjonegoro told an IIF panel session.

“We don’t know what’s going to happen to China in the future” in terms of growth, Brodjonegoro said, but it’s clear Indonesia will have to rely more on manufactured exports, rather than resources, in the future.

Indonesia is attracting more manufacturing investment from China, Japan and South Korea and needs to maintain its competitiveness to keep the money coming, said deputy governor Warjiyo, but should resist further currency depreciation. The rupiah had fallen by nearly 17 percent since September 2014, hitting a low of 14,662 to the dollar earlier this month, before it rebounded by nearly 10 percent, to 13,351. Even at that level, though, “the rupiah is still undervalued,” Warjiyo said.

And although fear of higher U.S. rates has contributed to the capital outflow from emerging markets, Warjiyo joined a growing chorus of EM officials at the Lima meetings in urging the Fed to hurry up and get off zero, arguing that uncertainty about the timing was causing more trouble than any 25 basis-point hike is likely to do.

“Sooner is better,” said the central banker. “The first move of the dance is usually the most difficult thing. But we have been living with uncertainty for so long.”

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