Argentina, Brazil, Greece, India, El Salvador – many of the emerging markets (EMs) had cracks in their foundations even before the Coronavirus-induced depression, proving to be fragile states that would implode at the first sign of an economic downturn. As history has shown, anytime there is a recession, emerging markets fall like dominoes. The nations of the developed world are attempting to contain the pandemiconomy and repair their respective economies by applying an expensive concoction of fiscal cures and monetary tools. Will developing nations mirror the policies of their wealthy counterparts, or will they require a lifeline from an external source to escape the financial crisis?
According to new data from Bloomberg Intelligence, more than a dozen EM central banks have either purchased government bonds or announced intentions to do so. What makes this a risky endeavor is that these nations possess fragile currencies and are witnessing a capital exodus. If central banks are monetizing federal deficits, there will inevitably be a sharp currency sell-off, which will deepen the economic downturn and heighten dependence on external financing.
They have already seen a decline in their currencies. The Brazilian real, the Mexican peso, the Argentine peso, and the Indian rupee are just some of the EM currencies to endure monumental crashes.
A Dire Situation
During the boom phase of the business cycle, emerging markets were viewed as incredible financial opportunities for yield-starved investors. With the bull market’s peak imminent, the smart money looked elsewhere for new opportunities and high returns. In their pursuit to find the next gold mine, a lot of parties buried their heads in the sand, ignoring the unsound fundamentals of these countries.
From ballooning debt levels to vast public-private partnership (P3) corruption, many of the emerging markets were on the cusp of collapse amid weakness on a larger scale. Now that the world appears to be coming to an end thanks to falling energy prices, a highly infectious respiratory illness, and a tsunami of inflation, the Indonesias and the Columbias of the world are in dire straits with no nepenthe in sight.
Eurasia Group, a risk consultancy group, sounded the alarm in its analysis that highlighted how EMs could risk getting “left behind” in this uncertain time. Robert Kahn, director of global strategy and global macro at the firm, told CNBC:
“One of the real concerns we have is that many emerging markets get left behind, that they’re not able to re-engage in global activity at the same pace as the industrial world. They face restrictions, they face ongoing challenges, they don’t have the checkbook to deal with that.”
The numbers and estimates are starting to pour in, and they are not pretty. Moody’s Analytics turned heads when it warned that defaults by EM businesses could soar over the next 18 months. Its forecast projected that the speculative-grade default rate for these companies could surge to as much as 11.2% by the end of this year and 13.7% in 2021: a direct result of the economic fallout from the pandemic and the damage it has done to business activity. The agency noted that governments’ failure to handle the public health crisis and the collapse in crude oil prices led to business closures, sliding domestic aggregate demand, a crash in export orders, and plunging liquidity.
Since January 2020, there has been about $80 billion in investment outflows among EMs. It may not be surprising to realize that the only EM country not to feel the pain of capital outflows is China. Beijing has enjoyed $10 billion in net inflows. If these figures are not scary enough, just think that the EM world has yet to hit the peak.
Since debt and deficits have been the norm for years, it can be hard for policymakers to unleash fiscal measures to stimulate the economy. But their central banks are adopting the same quantitative easing efforts as the Federal Reserve, the Bank of Canada (BoC), and the European Central Bank (ECB).
As bearish conditions intensify, new and unconventional measures are being studied. Thailand is mulling yield-curve control. Brazil wants to expand the central bank’s bond-buying powers. Chile is working to institute a constitutional amendment to allow the central bank to become a buyer of last resort. Turkey has accelerated its debt purchases as the government borrows unprecedented sums of money to reverse the downward trend.
There is also an issue of accountability. Anytime there is a crisis, unscrupulous folks come out of hiding and take advantage of the situation. Since cronyism and corruption are genuine issues in these places, it is more than likely that odious players will reach their hand into the printing press to grab their share of Hungarian forints, Chinese yuan, and Iranian rial.
The long-term consequence for these countries is that their credit ratings could be downgraded to junk status – Columbia, Indonesia, and Mexico have already faced the wrath of a rating reduction. Any indication of rising inflation or capital flight could force central banks to tighten monetary policy, which would send financial markets into a tailspin. Some say that the credibility of these central banks would also be extinguished, proving that they are incapable of mitigating an economic collapse.
An Empty Refrigerator
When the coronacrisis is etched in history and becomes an unpleasant memory, emerging markets will have no other choice but to request outside assistance – or, as former Vice President Joe Biden would call it, “economic intercourse.” This has typically been the case throughout modern history. The difference this time, however, is that everyone will be broke for years to come as they try to prevent a full-blown meltdown. After consuming all the groceries right after a trip to the supermarket, the global economic cupboard is bare, and we will be out of groceries for some time.
Read more from Andrew Moran.
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