Sovereign risk: Falling Brics

Sid Verma
Published on:

A Euromoney survey of economists and strategists paints a bleak picture of the emerging markets in 2016. They are now seen as a risk to global growth just when the developed markets start a modest recovery. On the positive side respondents reckon EMs will comfortably absorb the impact of US rate hikes and think another eurozone debt crisis is unlikely.

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In 2015, emerging market economies, led by four of the Brics – Brazil, Russia, China and South Africa, but not India – effectively ground to a halt. Capital flows vanished, corporate leverage jumped and currencies tumbled to historic lows. The 7.6% expansion notched by developing economies in 2010 capped a decade of spectacular growth. But this rate of growth has slid year-on-year to a projected 3.2% in 2015. With EMs growing barely a percentage point faster than developed economies, the investment case is unravelling. 

Against this challenging market backdrop, Euromoney invited economists, investors, risk analysts, bankers, corporate treasurers and fixed income strategists to participate in a sovereign-risk survey to gauge opinion on global and regional challenges. We received responses from more than 100 institutions. 

In particular, respondents highlight the weakness of EM credit fundamentals as the principal driver of risk deterioration rather than the difficult external financing environment. This stance contrasts with emerging-market policymakers, who grumble that exchange rates and equity markets have fallen below valuations implied by medium-term fundamentals

Rank the biggest risks facing global economic growth in order of importance 
Rank number
1 High uncertainty over G7 central bank policy
2 Commodity price shock
3 Global deflation
4 Another economic shock in China
5 Middle Eastern conflicts
6 Flare up in the eurozone sovereign debt crisis
7 Premature US Federal Reserve policy tightening

Source: Euromoney

Asked to rank the biggest risks facing global economic growth in 2016 in order of importance, they cite: uncertain G7 central bank policies creating market volatility; the commodity-price shock; and the risk of global deflation. By contrast, China, Middle Eastern conflicts, the eurozone and premature Fed hiking are ranked lower. The fact that US monetary tightening was seen as the least important out of the seven hazards for the global economy underscores market confidence that monetary conditions will remain broadly accommodative. 

When asked to be specific about US interest-rate rises, 70% shrug off the impact, 24% believe it will hamper growth, but only 6% think it will cause prolonged market dislocation. This finding strikes a chord with the growing belief among analysts that it is the uncertainty over G7 central bank policies – and not rate rises themselves – that is one of the biggest external drivers of capital-flow volatility in emerging markets. 

How worried are you about US Fed rate hikes?
Source: Euromoney


Rank your eurozone fears for 2016 in order of 
1 The refugee crisis
2 the rise of anti-austerity parties in the periphery
3 Greece’s economy
4 ECB QE causing price distortion
5 Lack of business investment
6 Failure to embark on structural reforms
7 Bad debts hampering credit growth

Source: Euromoney

For the eurozone, respondents say the refugee crisis is the single biggest threat for 2016, followed by political pressure to ease austerity and Greece. Less weight is given to traditional concerns, such as the lack of business investment, a failure to reform and bad debts.

The risk of bad debt damaging eurozone credit supply is deemed the least-important out of the seven concerns for the single-currency bloc, reflecting a positive outlook for bank-credit supply and household demand in northern Europe. There is also some evidence that deleveraging in the business sector in southern Europe, principally Spain, has cooled. Bank credit to eurozone businesses recovered 0.6% year-on-year in October, the latest data available, while lending to eurozone households reached 1.2% year-on-year.

Rank your emerging markets fears in 2016 in order  of importance 
1 Weaker trade undermining balance-of-payments
2 Strong dollar
3 Weaker Chinese growth
4 Weak productivity gains
5 Tighter financial conditions 
6 Middle Eastern tensions

Source: Euromoney

Asked to rank emerging market-specific fears in 2016 in order of importance, respondents cited weaker trade, a stronger dollar, China, productivity falls, tighter financial conditions and Middle Eastern tensions. Trade grew 2.8% in 2015 compared with an expected global GDP growth of 3.1%, reversing the decades-long trend of trade expansion outpacing GDP growth.

For 2016, fears are growing that weaker trade – driven by China’s waning commodity demand and Brics import demand as a whole – will again lead to a deterioration in balance-of-payments positions among exporting nations from Asia to Africa, weakening their ability to service foreign debt.

Dollar outlook

The outlook for the dollar is crucial for developing markets – its strengthening has historically preceded crises from Asia to Latin America. Respondents say a stronger dollar is the second biggest risk for emerging markets. Since 2009, the weakness of the dollar, combined with easy US monetary conditions, fuelled the global debt and liquidity cycle. These conditions allowed US banks to increase their foreign holdings and depressed yields on conventional asset classes, triggering a demand for EM assets and a surge in private-sector indebtedness. The Bank for International Settlements calculates net non-bank private debt issuance from emerging markets grew $660 billion between the fourth quarter of 2008 and the third quarter of 2014.