Question

The “Fragile Five” is a term coined in 2013 that identified five major emerging market economies that ran large, persistent current account deficits. Why might running chronic currentaccount deficits render an economy fragile? Could this term apply to countries that run chronic current account surpluses?

Answer 1

The "Fragile Five" is a term coined to indicate emerging market economies that are overly dependent on unreliable foreign investment to finance their growth ambitions. After many developed economies slowed down in 2008, EME's became the new investment havens for investors due to their relatively strong growth rates. However, when recovery took place in the developed world, these EMEs faced the risk of capital flight with investors selling off these investments to move their money back to US and other developed countries. Too much reliance on foreign inflows exposed the EMEs to substantial risk from external economies - For example, firstly foreigners had greater claim on domestic assets, secondly, with the sudden capital flight EME currencies weakened sharply and lost value making it hard to sustain their huge current account deficits.

Chronic current account deficits that are financed solely through surplus in capital account that stems from foreign inflows are hugely unreliable and are only short term ways of spurring output and growth.

However, this term is not appropriate for countries that run chronic current account surpluses since they are lenders to the rest of the world and their combined savings rate (private and public) are greater than their rates of investment.