Another year brings another warning about the implications of possible higher interest rates. How seriously should emerging market sovereigns take these cautionary forecasts?
Similar challenges were predicted in 2005, yet in the event interest rates remained stable and low. This, coupled with the fact that last year there were record emerging market inflows ($358 billion according to the Institute of International Finance), suggests that such fears might be overstated.
Global risk appetite and liquidity have been very important to emerging market spread tightening in recent years, with risk appetite stronger than ever. This will have the effect of turning investors’ attention to economic fundamentals more than the search for yield that has dominated in recent years. Harsher financing conditions will certainly expose poor fiscal performers.
Latin American and emerging European economies are most at risk of higher interest rates, according to IMF statistics. These predict the impact of a 300 basis point increase in interest rates as a percentage fall in different regions’ GDP. Latin American countries, it says, should see something like a 1.02% impact, while emerging European ones should expect nearer 0.98%. Asia Pacific countries, with their relatively lower debt burdens, are likely to be best off, with a 300bp rise having an impact of less then 0.5% of GDP.
The improvement in emerging markets economies is continuing apace. Just last month, for example, Standard & Poor’s revised its rating outlook for Turkey from stable to positive, suggesting that its BB– rating could be upgraded before long.
However, the recent worsening in Turkey’s current account and private sector indebtedness raises the issue of medium-term external debt sustainability. Analysts say that Turkey remains vulnerable to changes in global liquidity and risk appetite.
Regardless of whether they entirely believe it, emerging market borrowers will do well to brace themselves for higher interest rates, especially those that rely heavily on external debt markets for financing.