An EM Crisis Is Not ‘Coming’ – It’s Already Here, One Bank Says

There’s a solid case to be made that thanks to a variety of mitigating factors, many emerging markets may be in a better position biologically speaking to weather the COVID-19 storm than advanced economies.

JPMorgan’s Marko Kolanovic outlined some of those factors in a sweeping analysis on Thursday. As ever, his take is trenchant and to the extent it’s borne out, it will be welcome news for the world.

One reason it’s crucial to assess how vulnerable populations in emerging markets are to coronavirus is that, generally speaking, they may have rickety healthcare compared to developed economies and, as noted in the linked post, they have external funding needs and fragile currencies. As Kolanovic himself puts it, “the premise of an even bigger EM disaster would be their weaker health care systems, and the fiscal and monetary constraints in developing economies”.

Well, if you ask Credit Suisse’s Kasper Bartholdy “an EM crisis is not ‘coming’ — it is already here”.

Bartholdy doesn’t take any real position on the relative biological vulnerability of developing economies to deadly pathogens. Rather, he looks at the issues noted above on currencies and external funding needs.

Right up front, he addresses China and South Korea which, in his estimation, will probably be ok, given that their epidemics are under control and they don’t depend on financing from abroad.

For countries in EEMEA and Latin America, however, it’s a different story, Bartholdy cautions.

“Many of the countries in that part of the world have just been hit by a sharp fall in revenues from exports of goods and services, commodity prices have tanked, and incoming tourism has stopped”, he laments, adding that for many of these nations, access to funding in international markets “has come to a near-complete halt”.

Obviously, one of the main concerns during the current crisis (and, really, during any crisis) is market access for developing economies. The IMF has rushed to address this in recent days. On Wednesday, for example, the fund rolled out short-term liquidity lines aimed at supporting countries with otherwise strong fundamentals.

“The facility is a revolving and renewable backstop for member countries with very strong policies and fundamentals in need of short-term moderate balance of payments support”, managing director Kristalina Georgieva, said. “In these cases, the short-term liquidity line will provide revolving access of up to 145 percent of quota”. This was tipped last month, and I discussed it at some length in the context of the Fed’s swap lines and foreign repo facility in “The World Desperately Needs More Dollars. And The IMF Knows It“.

“The problem is gigantic and we have to move rapidly”, Georgieva said Thursday, speaking to Bloomberg TV about potentially dire financial straits for some developing economies. The IMF, she said, is looking to avert a situation where liquidity problems become solvency issues. In essence, that’s the problem for the whole world right now – indeed, earlier this week, the Atlanta Fed’s Raphael Bostic described the plight of small businesses in the US in almost identical terms.

Credit Suisse’s Bartholdy frets that in addition to curtailed access to capital markets, outflows and a halt in foreign direct investment, “many countries in Latin America and EEMEA have decided to implement lockdown policies, so their production is falling not only because of the negative shock to export demand, commodity prices, and capital inflows, but also because of social distancing policies at home”.

And there’s more. Consider the following from Bartholdy on the impact of shifting terms of trade:

On top of this, in many of the countries in EEMEA and Latin America, the decline in real GDP figures understates the underlying drop in real incomes. This is because the real GDP figures are defined as “changes in GDP, with GDP measured at constant prices”. One implication of that definition is that real GDP changes fail to capture the loss of real income that derives from the phenomenon that economists refer to as “changes in the terms-of-trade”. That term refers to a shift in the ratio of export prices to import prices. Russia, for example, has been hit in recent months with a sharp fall in the dollar-price at which it can sell its oil and natural gas output to the rest of the world. The drop in oil prices will, in the absence of a corresponding decline in the dollar price for Russia’s imports, cause Russia’s purchasing power (the quantity of imports it can buy for a given quantity of its exports) to drop. That will be true even if there is no change in the volume (i.e. the number of physical units) that Russia produces and if, for that reason, there is no change in Russia’s real GDP. Generally speaking, in periods with commodity price declines, real incomes in commodity-exporting EM countries will decline more substantially — in some cases much more substantially — than real GDP in the same countries.

All of this is problematic, to say the least, and it speaks to why some are concerned that irrespective of whether coronavirus outbreaks in developing economies worsen to the extent they have in the developed world, the financial strain could be acute.

The key question, Credit Suisse reminds you, is simply this: “How do all the different lines in the balance of payments of the EM countries manage to add up to zero?”

Amid portfolio outflows and declining export revenue, there are (basically) just four answers to that question. They are, Bartholdy writes, as follows: a slowdown of FX reserves accumulation, a fall in imports, capital flow restrictions and/or external debt default.

None of those options are particularly palatable, and are more or less feasible depending on the locale.

Right now, serial defaulter Argentina is in restructuring talks, Mexico and South Africa are letting their currencies “do the work they should do” (to quote Credit Suisse) while Turkey is, as usual, fighting tooth and nail with markets.

Turkish banks have been blowing through billions to defend the lira, and that can only go so far. Citi suggested this week that the lira “is the new rand”.

“Traders are the most bearish on the lira relative to the rand in 10 months, based on the cost of hedging against declines using put options”, Bloomberg wrote Thursday, flagging a widening disparity in riskies.

Fighting the market is an uphill battle, and as Bartholdy cautions, “doing so [puts Turkey’s] ability to service the country’s external debt at risk”.

(Credit Suisse)

Of course, this is something of a Sophie’s choice. While it’s generally advisable for EMs to avoid burning through reserves to defend their currencies, Credit Suisse reminds you that “currency depreciation is not a free option [as] it causes losses and balance sheet problems for EM companies that have borrowed in dollars but earn their revenues in local currency terms”.

In addition to that, a plunging currency can create domestic political problems. To quote Pablo Escobar (as he was portrayed in Blow), autocratic leaders like Recep Tayyip Erdogan “don’t like problems”.

Ultimately, Bartholdy’s message is simple. “An EM crisis is not an abstract possibility — it is the current reality”.

And yet, he acknowledges that there’s something trite about speaking in terms of currencies, debt and balance of payments during a pandemic. But, he says, somewhat fatalistically, “that is our job”.

On that note, I’ll leave you with one last excerpt from his note. To wit, from Credit Suisse:

On top of these economic considerations lies the direct impact on peoples’ welfare of the existence of the new corona virus. People that contract Covid-19 or any other disease in the EM countries right now will in many cases be faced with national health systems that are very poorly resourced by the standards of the developed world. Finance ministers in the EM countries in most cases have little fiscal (and balance of payments) room to curb the resulting cut in the local population’s standard of living through the type of generous packages of compensation-for-income-losses that governments across much of the developed world are implementing right now. So from the perspective of people that earn their living in the EM countries, a truly daunting crisis is unfolding. Seen against that background it may seem mundane to discuss the interaction between macroeconomics and asset prices in the EM countries, but that is in our job description, so that is what we will do now.


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One thought on “An EM Crisis Is Not ‘Coming’ – It’s Already Here, One Bank Says

  1. I remember that a year out from 9/11, because of the shock to trade, the amount of people who died of starvation in the world rose dramatically.

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