"Fragile Five" Is the Latest Club of Emerging Nations in Turmoil

By Landon Thomas Jr.

New York Times

The long-running boom in emerging markets came to be identified, if not propped up, by wide acceptance of the term BRICs, shorthand for the fast-growing countries Brazil, Russia, India and China. Recent turmoil in these and similar markets has produced a rival expression: the Fragile Five.

The new name, as coined by a little-known research analyst at Morgan Stanley last summer, identifies Turkey, Brazil, India, South Africa and Indonesia as economies that have become too dependent on skittish foreign investment to finance their growth ambitions.

The term has caught on in large degree because it highlights the strains that occur when countries place too much emphasis on stoking fast rates of economic growth. The new catchphrase also raises pressing questions about not just the BRICs but about emerging markets in general.

The Morgan Stanley report came out in August, when there were reports that the Federal Reserve would soon reduce its bond-buying program. The term that report coined became a quick and easy way for investors to give voice to fears of a broader emerging markets rout, propelled by runs on the Turkish lira, Brazilian real and South African rand.

These fears were realized this week when Turkey, seen by most investors as the most fragile of the Fragile Five, raised interest rates 4.25 percentage points on Tuesday.

The sharper-than-expected increase by the country’s central bank — which previously took a fairly passive approach to defending its currency — was intended to persuade foreign investors, as well as corporate and household savers, to hold on to their lira instead of exchanging them for dollars.

As with other members of the Fragile Five, Turkey relies heavily on fickle short-term investment from foreigners to finance gaping current account deficits — the result of which has been a currency that many investors say is overvalued.

Investment analysts love to come up with catchy names that simplify their views and, ideally, capture the market spirit of the moment. During the early period of the euro crisis, PIGS, unkindly, came to describe Portugal, Ireland, Greece and Spain. And when the focus turned to Greece and its future in the euro zone, Grexit became the term of art.

Not all of them catch on. In September, Deutsche Bank analysts came up with Biits, which covers the same countries as the Fragile Five, but it graced hardly any analysts’ reports.

The countries in the Asian financial crisis of 1997 never got saddled with a nickname. As in that and other emerging market blowups, foreign investors and lenders pulled their money out because of broader concerns about political and economic uncertainty.

And while there have been sharp outflows from Turkey and some of the other members of the Fragile Five, broadly speaking, foreign investors have retreated from the asset class as a whole.

None of which surprises Jim O’Neill, who, as an economist at Goldman Sachs in late 2001, came up with the phrase BRICs as a way to highlight the long-term growth potential of large emerging market economies.

 “I still believe these are the best investment opportunities in the world,” said Mr. O’Neill, who acknowledges being irritated at having to defend his thesis every time there is an emerging market wobble.

Mr. O’Neill, who recently left Goldman and now works independently, has just come up with yet another, similarly dynamic club. This one, of populous countries with high growth potential, he calls MINTs, for Mexico, Indonesia, Nigeria and Turkey.

When Mr. O’Neill coined the BRICs phrase, foreign capital inflows into emerging markets were about $190 billion a year, according to data from the Institute of International Finance, the trade group for international banks.

His timing could not have been better: The Federal Reserve was moving to a policy of very low interest rates and China’s growth engine was revving up, driving what would become a long-running commodity boom.

Yield-starved investors began pouring into Mr. O’Neill’s markets and their economies. Since 2010, annual net inflows into these markets have averaged a little over $1 trillion a year.

As a result, Mr. O’Neill became quite the global man about town. He has been celebrated by investors and the BRIC nations themselves, which even formed a BRIC-development bank.

All this changed last summer, when the Fed’s announcement that it would eventually reverse its bond-buying program panicked giddy emerging-market investors. Other concerns, like a slowdown of growth in China, political uncertainty in Russia and Turkey and most crucially, vulnerable currencies in Brazil and South Africa, spurred concerns over the possibility of a broader market panic.

So in early August, when James K. Lord, a fairly junior currency analyst at Morgan Stanley sent out a research note warning of the risks within the “fragile five,” the name spread quickly, especially among investors already nervous about their emerging-market holdings.

Turkey, more than any of the others, has been the primary target. Since May, foreign investors have sold, in net terms, $3.9 billion worth of lira-denominated bonds, according to data from the Institute of International Finance, a substantial amount for such a short period.

Although Mr. O’Neill, while at Goldman, aggressively marketed his BRICs notion, Mr. Lord and his team at Morgan Stanley have been more circumspect, avoiding for the most part public statements in the news media.

In response to questions about his Fragile Five thesis, Mr. Lord, who this year was promoted from vice president to a more senior position, asked that he be quoted playing down his original thesis.

“We have been using the term less and less in our research,” he said, explaining that responses by policy makers in these countries have to some extent addressed the issues he raised.

That is not surprising. Banks are always wary of promoting critical investment calls, especially when important, fee-generating nations like Brazil and Turkey are concerned.

But more skeptical investors remain less inclined to view currency-stabilizing steps taken by Turkey and other Fragile Five members in such a sanguine light.

“People made mistakes investing in these markets just because of the headline G.D.P. and demographics,” said Stephen L. Jen, a former economist for the International Monetary Fund who now manages a hedge fund based in London. Important issues like corruption and governance, not to mention excessive lending in urban areas that favored the political and economic elites, have been ignored, he pointed out.

“Istanbul does not need 100 malls,” he said. “There is a reason these people are poor.”

Mr. Jen did make a stab at crafting his own catchphrase and considered adding Russia to transform the Fragile Five into the Sorry Six, before ditching the notion.

Better to keep it simple, he said, and steer clear of currencies with four letters: the Mexican peso, the South African rand, the Brazilian real and, of course, the Turkish lira.

A version of this article appears in print on January 29, 2014, on page B1 of the New York edition with the headline: Coinages in the Financial Realm: After BRICs Fall, the ‘Fragile Five’.