Country risk debate: Does the recent sell-off in emerging markets constitute a crisis?
With EM currencies and assets remaining highly volatile amid the recent market sell-off, we ask three Euromoney Country Risk experts whether a wider economic crisis is on the horizon.
Alvaro Ortiz Vidal-abarca, chief economist cross country emerging markets at BBVA, Spain
I consider the actual situation as an outgoing adjustment process in international portfolios. The decisive actions by the ECB and the QE3 during the summer of 2012 triggered massive inflows in the emerging markets assets. We estimate that the extra inflows from these “push” factors reached near $200 billion. Once the Fed announced the gradual return to normality during May 2013, international investors started to sharply rebalance their portfolios. The initial reaction was stronger than expected and we need to understand the role of the technical factors in the correction. We estimate that most of the previous excess has been corrected, and we are now in an undershooting phase. In any case, markets have started to diversify.
Beyond this, emerging markets vulnerability is at historical low levels. True, there are countries with “flow” problems, especially those related with excessive current-account deficits, but the underlying vulnerability is clearly lower for several reasons.
First, “stock” vulnerability is lower than ever, with public, external and private debt levels at historically low levels. The long-lasting deleveraging of emerging markets after their crisis resulted in public and private balance sheets which were really clean when the latest financial crisis erupted.
Second, maturity and currency mismatches have been reduced significantly since the end of the Nineties. The traditional maturity mismatch has clearly improved and some of the emerging markets are now able to finance at longer terms. Besides, the currency mismatch is now lower and foreign exchange-denominated liabilities have been reduced significantly. This, and the implementation of flexible exchange rate by most of the emerging markets have reinforced the role of exchange rates as shock absorbers rather than shock amplifiers.
Harry G Broadman, chief economist, PwC
The recent downdraft in currency and stock-market values in certain emerging markets has engendered concern we are witnessing a repeat of the deep and prolonged crisis at the turn of this century, when contagion affected a wide swath of emerging markets. This time is different, however. First, over the last decade and a half, most emerging markets have experienced sustained growth in real GDP. Indeed, on average, emerging markets have grown at least twice the rate of advance countries. In most cases, this economic performance is the result of hard-won reforms and deft economic policymaking. It reflects a secular change in the world economy.
Does this mean that economies are immune from cyclical changes? Of course not: the business cycle is hardly dead – either in emerging markets or elsewhere in the global economy. In fact, in contrast to the earlier currency crisis, that is why most, if not all, of today’s volatility in emerging markets fundamentally stems from organic, behind-the-border economic or policy imbalances within each country, and we are not witnessing broad contagion.
Most emerging markets have learned the painful lessons from the past: along with the adoption of flexible exchange-rate regimes, they have followed far more prudent foreign borrowing practices, built up sizeable reserves, decreased protectionism, and infused their markets with greater agility. At the same time, investors have become more discriminating. They have also proven to be less inclined to engage in binge investing. Like their emerging market policymaking counterparts, they have learned that, in the end, credibility is absolutely crucial.
It should not be a surprise therefore that unless – and until – certain emerging markets take timely and decisive measures to address the weaknesses in their behind-the-border policy frameworks, their currencies and asset values will continue to be quite choppy and significant market corrections will continue.
Colen Garrow, chief economist at Meganomics, South Africa
A 50 basis point hike in the South African Reserve Bank’s (SARB) policy rate lifted rates from the lowest they have been in 40 years, but it is unlikely to either stabilize the rand exchange rate or put a lid on the rate at which prices are growing. As important as it to preserve its inflation-fighting credentials, the MPC may have unwittingly unlocked a series of interest-rate increases. The cue currency speculators now have is that the rand may be a one-way bet again, since monetary policymakers have shown a willingness to curb increases in prices that they have little to no control over. Tighter monetary policy is a blunt instrument in cases where wage inflation has been precipitated by prolific strike action in the supply sectors of the economy, where administered prices are increasing, where food inflation is impacted by drought in other parts of the world, and where fuel and electricity prices are rising. All these factors are exogenous.
As is the influence of the recovery in the US, which is bringing to a quicker-than-expected end to QE, and in turn the attraction of high-yielding emerging-market currencies, like the rand.
Also not helping the local exchange rates is the impact of the twin deficits. A current-account deficit of more than double the -3.0% of GDP yardstick remains attractive to currency speculators who wish to short the rand, as is the fiscal slippage that has taken place, and pushed the fiscal deficit to around 5% of GDP. Speculators sense also that with national elections pending over the next few months, political risk has risen, giving them an uneasy confidence to push the rand weaker, testing the resolve of the SARB to hike its policy rate even more.
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