Sunday, 16 June 2019

Emerging markets face a tough year with no saviour

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  • James Saft

Jim Saft on the tight squeeze on EMs.

A 2014 crisis in developing nations, if it comes, will underline a critical weakness of emerging markets: they are a concept rather than a polity.

Unlike previous recent crises, first in the US and then Europe, it is unclear what institution has both the will and the means to stand as a backstop if emerging markets as a group experience a crisis.

The IMF is arguably under-gunned, the Federal Reserve and European Central Bank are both responding to complex and diverging domestic developments and central banks within emerging markets are likely to be both too small and pulling in different directions.

After a tough year in market terms in 2013, emerging markets face a number of critical challenges in 2014.

First, from a very long-term point of view, it appears that a long boom in commodity prices, a classic driver of growth in emerging markets, has played itself out. This will pressure budgets and crimp growth.

More immediately, emerging markets countries, many of which have to attract capital to make up for current account deficits, are ill-prepared after enjoying easy conditions not of their own making for years.

Very easy money from the Federal Reserve, augmented by other central banks, made life in the global capital markets a borrowers paradise, but many countries did little by way of fundamental reform to prepare for tighter times later. That is now ending, or has ended.

The Bank of China will look after China, a relief for the rest of the world, but something which may only leave those emerging markets without the means to weather their own storms more exposed.

As the Fed backs away from buying bonds, tapering its purchases in coming months, monetary conditions globally will become tighter, with those who need money most the most affected. Emerging markets, including India, South Africa and others, are the ones which need money most. This will only be exacerbated by a widening gap between growth in emerging and developed markets.

“Emerging markets knew well that the capital inflows they were receiving from 2009-2012 were one day going to leave, and had few macro tools to either absorb or block out these flows,” hedge fund manager Stephen Jen, of SLJ Macro Partners wrote in a note to clients.

“This was why we have long described the impending EM crisis as the necessary third phase of the global financial crisis.”

In Jen’s view, what we have had since 2008 is essentially a rolling global crisis.

First came the sub-prime mortgage episode in the U.S., punctuated by the failure of Lehman Brothers, and only arrested at great cost and with uncertain long-term results by the combined efforts of the Fed and the U.S. Treasury.

Next came the euro crisis which itself was far harder to counter because of institutional arrangements in Europe. Only after much difficulty did the ECB step in in 2012 to provide an effective backstop for weakened peripheral states, such as Ireland, which otherwise might have faced a financing death spiral.

No bold moves

Of course there is no Fed or ECB of emerging markets, or at least not one with the size and remit to allow it to make. The IMF probably has not got the firepower, and while its thinking has evolved from the days in which it expected troubled borrowers to starve themselves to health, it is highly unlikely to make a move as bold as that of the ECB in August of 2012, when Mario Draghi pledged to do “whatever it takes”.

The Bank of China will look after China, a relief for the rest of the world, but something which may only leave those emerging markets without the means to weather their own storms more exposed.

Even if Russia becomes involved, as well it may, the sheer weight of the economies which face difficulties may not be enough to make the Federal Reserve think twice about pursuing its own domestic aims.

Just as the Fed did not intend to create conditions in recent years which were far too loose for emerging markets, nor will it in 2014 intend to make things for developing nations far too tight. Emerging markets will simply be collateral damage.

If the Fed does carry on with its apparent plan to rapidly cut back on bond buying, the best we can hope for is a year which is ugly for emerging markets from an investors’, or inhabitants’, point of view, rather than one which features a genuine funding crisis.

If so, the third phase of the global financial crisis may prove the hardest to arrest but the least damaging to the global economy.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at

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