Developing Nations Anxiously Watch Fed at Jackson Hole

Central bankers fueled an emerging-market credit boom that could deflate when they change course.

Emerging markets used to be for the few brave investors willing to trade high risk for high rewards. Countries even riskier, like Zambia and Pakistan, were for the real cowboys. No longer. Since the financial crisis spurred central bankers to hold down interest rates, investors have poured billions of dollars into emerging and frontier markets.

Now, all eyes are on the U.S. Federal Reserve and its annual conference in Jackson Hole, Wyoming, which begins Friday and will feature speeches by Federal Reserve Chairwoman Janet Yellen and European Central Bank President Mario Draghi. The Fed is expected to end its stimulus program this fall and start raising interest rates next year; any sign that Yellen is changing course and raising rates sooner could rattle investors, not only in emerging markets, but across all assets.

As developed economies stagnated after the financial crisis, the Fed pushed more money into the system to try to spur growth. Interest rates on safer assets in the United States and Europe fell and investors started looking for higher returns from riskier assets. That's how they ended up buying bonds from Ivory Coast, Cyprus, Ecuador, and similar nations.

The IMF estimates that investments in bonds from emerging-market countries like Brazil, China, and South Africa have more than doubled over the past few years. Since 2010, foreign holdings of emerging-market debt have expanded from $400 billion to $1 trillion. Frontier markets, a rough set of countries even newer to the international market than "emerging" countries, are also expanding like never before. That group, which includes Kenya and Ecuador, sold $20 billion worth of bonds last year, according to the Financial Times -- twice what was issued in 2012. Fourteen countries issued their first bonds in 2010 or later, for a total of $8.5 billion worth of debt, according to a recent IMF paper.

That dynamic has economists worried that when the Fed raises rates, investors could pull their money out of emerging-market countries and put it back in the United States, where they would be getting solid returns for far safer assets. That kind of move could wreak havoc on the economies of developing countries because a drop in the value of their currencies would mean they would have a harder time paying back their bonds, which are usually denominated in dollars or euros.

Nicholas Spiro, a sovereign-debt analyst in London, said investors have plowed money into far-flung markets because of the Fed's easy-money policies. When the investment tide flowing into emerging markets recedes, it will reveal who took on bets that were too risky or who is "swimming naked," he said, paraphrasing Warren Buffett's famous line.

"It's already clear which of the swimmers have skimpy bathing suits," said Spiro, the managing director of his own Spiro Sovereign Strategy. "None of these swimmers want to put on full-fledged diving suits."

Beyond overexposed investors, experts worry about what will happen to the countries that are borrowing money by issuing bonds. Charles Blitzer, a private consultant who previously worked on sovereign-bond defaults at the IMF, said he's particularly concerned about small African countries that have less experience selling bonds.

"There's a lot of dumb borrowing going on and, of course, dumb lending," Blitzer said. "Some of that is going to end up in trouble."

Blitzer said leaders who make mistakes setting up their bond offerings in the beginning make it harder for their governments to pay the money back over time. Sometimes, for instance, officials structure the debt to come due all at the same time, which makes it more likely that one bad economic event will force a country into default.

"None of the finance ministers want to admit that they don't have the experience," he said.

Blitzer points to Angola, which has chosen in the past to issue debt through expensive private placements with investors, rather than selling bonds on the open market. Private placements make it harder to track the debt, Blitzer said, because the details of the sales aren't public. Angola borrowed $1 billion this way in 2012, but the government has long discussed issuing publicly-traded bonds.

"Angola would be well advised to take whatever rating they can get from the rating agencies and proceed into public markets," said Blitzer.

Despite being the third-largest economy in Africa, Angola has dismal ratings on corruption. Transparency International ranked Angola 153rd out of 177 countries in its corruption perceptions index. The Angolan government recently put off opening a stock market until 2017, according to Bloomberg, so that its companies can clean up their finances.

Though corruption threatens to get in the way in some places, each country's situation is different. The flood of cheap debt also gives governments the chance to invest in boosting economic growth. Senegal, which has a higher credit rating than many other frontier markets, including Angola, sold $500 million worth of bonds this year. Senegalese officials told Bloomberg the money will go to building roads and improving access to electricity in order to better attract foreign investment in the country's mining sector.

Gabriel Sterne, head of global macro investor services at Oxford Economics Ltd. and a former IMF and Bank of England economist, warned in a recent paper that investors have been so eager to buy emerging-market debt that it has made it cheaper for those countries to borrow. Lenders usually demand higher interest rates from borrowers -- countries, companies, or individuals -- that are considered more likely to default on their loans. But when there are lots of lenders in the market, or lots of bond buyers, interest rates drop. Stern warns that, historically, 24 percent of countries that are rated as riskier investments by credit ratings firms end up defaulting.

"Eventually, when the Fed and the ECB start raising rates, they're not going to be able pay it back," said Diego Ferro, co-chief investment officer at Greylock Capital Management, based in New York.

Ferro has reason to be more sanguine about the risk, however. His firm makes money when a country can no longer pay its bills. He buys up bonds on the cheap when other investors flee and then negotiates with governments to get the best deal possible. His firm negotiated with Greece, Ivory Coast, and Belize when those countries defaulted on their debt.

"We should think about the positive side: In the past they weren't able to get money; now they can get it," said Ferro. "Is it bad? No one's forcing them to get the money."



The Green Devil

From logging Tasmanian forests to dumping in the Great Barrier Reef, Prime Minister Tony Abbott is the Australian environment's worst nightmare.

Hiking through the Tasmanian wilderness feels like a scene out of Jurassic Park. Overhead are the tallest flowering trees on the planet. Underfoot are so many layers of damp, mossy growth that, without stepping carefully, a boot could crunch right through. The Tasmanian devil lives here, and so do the platypus and wedge-tailed eagle; some Huon pine trees here are more than 2,000 years old. Located at the bottom of the world, Tasmania is a bioregion so unique that it is listed as a World Heritage site by the United Nations for "outstanding universal value." It satisfies more criteria for that designation than any other World Heritage site on Earth.

But for Australian Prime Minister Tony Abbott, this remarkable natural legacy isn't worth protecting. Instead, it should be stripped.

Soon after being elected in September 2013, Abbott started making plans to fulfill his campaign promise of removing some environmental protections on Tasmania's forest and opening it to industry, specifically logging. In March, he invited loggers to Australia's Parliament House and told them that members of the country's Green party were "the devil" and that "the environment is meant for man." The loggers were thrilled.

A few months later, however, Abbott had to convince a different audience of his proposal -- and this time, the response was not enthusiastic. When the World Heritage Committee of the United Nations Educational, Scientific and Cultural Organization (UNESCO) met in Doha in June 2014, it unanimously rejected Abbott's plan to remove 74,000 hectares of Tasmanian forest from its list of cherished sites. One delegate said the move would have set an "unacceptable precedent." The decision took less than 10 minutes.

It was a victory for the environmental community, in Australia and globally, but the international embarrassment didn't deter Abbott. As one World Heritage site was ostensibly spared, he was already setting his sights on another: He wants to dump millions of tons of dredged soil from a coal-port expansion into the Great Barrier Reef.

When asked about Abbott, Greenpeace Australia Pacific CEO David Ritter responds with a mixture of laughter and exasperation. "My daughters are 5 and 2 years old," Ritter says. "I have no idea how I am going to explain to them that, when they were children, the government of their country allowed this to happen to the Great Barrier Reef."

Ritter isn't alone. Australia's opposition leader, Bill Shorten, has called Abbott an "environmental vandal," and university researchers have said his first year in office has been nothing but an "environmental train wreck." This dates back to his very first day in office, when Abbott introduced legislation to repeal a carbon tax on Australia's most polluting industries. Soon after, a document created by Abbott's cabinet surfaced, stating that his administration would no longer tolerate "any measures which are socialism masquerading as environmentalism."

Abbott's critics are using Cold War rhetoric too. As Lyndon Schneiders, national director of Australia's Wilderness Society, writes in an email, "The Australian Government is taking environment policy back to the 1950s."

There have already been many battles, and casualties, in Abbott's war on the environment. In addition to supporting logging and mining at World Heritage sites, the prime minister has ignored the recommendations of his country's nonpartisan Climate Change Authority. He refused to send a delegate to the U.N. climate negotiations in Warsaw, Poland, last November. He has slashed $435 million in funding for the Australian Renewable Energy Agency, and he appointed Dick Warburton, a self-proclaimed climate change "skeptic," to review the country's renewable energy priorities. Meanwhile, Abbott's federal environment minister, Greg Hunt, has approved cattle grazing in the Wonnangatta Valley, which is part of the Alpine National Park -- a national heritage site.

On Aug. 14, Abbott's chief business advisor, Maurice Newman, created a stir when he said climate science was "warming propaganda" and that the planet could be facing a dangerous period of global cooling. The Labor Party's environment spokesman told the Guardian, "These kinds of comments would be laughable if he didn't have the prime minister's ear."

For Abbott, all environmental regulations are merely "green tape" that hold back corporate profits. He has hacked away at that tape by gutting the Environment Protection and Biodiversity Conservation Act, the legislative process for determining whether a development project is environmentally safe. Instead oil, gas, and mining permits are now funneled to other agencies where they can get a green stamp.

Even animals aren't safe from Abbott's slash-and-burn campaign. A shark cull, intended to find and eradicate man-eating sharks, has already killed 68 tiger, great white, and bull sharks in a three-month trial. Great whites are an endangered species, so the Abbott government simply exempted the state of Western Australia from federal laws protecting them. Abbott has also abolished the Australian Animal Welfare Advisory Committee and cut funding for animal welfare initiatives.

To make sure no one can adequately challenge his dictums, Abbott has eviscerated federal funding for programs such as the Environmental Defenders Offices (EDO), independent legal centers that operate in the public interest. "Without the EDO legal services many Australians could not afford to get legal advice or mount a legitimate legal challenge against large companies or governments over major development projects which threaten their local communities and environment," Sue Higginson, the principal solicitor with the EDO in New South Wales, said in a statement.

Abbott's anti-environment stance has raised eyebrows around the world. Environmental author Bill McKibben has written that Americans who traveled abroad during George W. Bush's administration should have sympathy for Australians right now: "[I]t's not easy being citizens of countries run by international laughing stocks." The comparison is apt: Like the Bush administration, Abbott chooses to ignore or undercut federal and international law when it doesn't suit his interests.

Yet he has no qualms about using the law as a political hammer to quash the opposition: In Tasmania right now, Abbott's Liberal Party government is backing a new bill explicitly drafted to stop environmental protesters. The Workplaces (Protection From Protesters) Bill is aimed at quelling those who "prevent, impede or obstruct the carrying out of business activities." Mining and logging industries are mentioned by name, but the bill is written so broadly that it could cover nearly any business. It includes a sweeping list of prohibitions against "protest activity," with fines up to $10,000 if demonstrations interrupt business -- and mandatory prison sentences for a second offense.

"This anti-democratic bill undermines basic principles of free speech and civil society," Miranda Gibson, an environmental activist and spokesperson for the group Still Wild Still Threatened, writes in an email. "The Liberals are clearly pushing this Bill in order to continue their assault on the environment free from scrutiny and criticism by the community."

The legislation could pass by the end of August.

Abbott's government has also spoken out in support of proposed laws to crack down on activists who photograph and videotape animal agriculture. These so-called "ag-gag" laws are modeled after similar efforts in the United States (currently being challenged in court). The primary industries minister of New South Wales has gone so far as to say that protesters who film animal welfare abuses on farms are "akin to terrorists."

When will the onslaught end? According to Bob Brown, a former senator and parliamentary leader of the Australian Greens, Abbott may very well be shooting himself in the foot with his nightmarish environmental policies -- losing public confidence and, potentially, votes. "Abbott is a political glitch," Brown says. "Young Australians are the key to his downfall. One poll showed that 97 percent of Australians aged between 18 and 24 opposed Abbott's failed attempt to remove World Heritage status from the tallest flowering forests on Earth, in Tasmania, so that they could be logged."

"Suddenly," Brown adds, "it is becoming difficult to find anyone who will freely admit to voting for him."

Photo by Scott Barbour/Getty Images