How badly have Emerging Market economies been hit by the crisis?
Covid-19 hurts developing countries in at least four ways: by damaging their export earnings, by deterring foreign capital, by weakening their currencies, and by raising the cost of their borrowing. For many Emerging Market (EM) economies, like Argentina, the root of the problem is that they do not collect enough foreign currency through exports or raise enough income through taxes to pay for their debt. Some EMs with relatively well-developed domestic banking systems, like the BRIC states and South Korea, can issue much of their debt in local currency. Botswana has no dollar bonds at all, preferring to borrow in local currency.
But Argentina’s banking system, like many others, is very small, largely because confidence in the stability of the devaluation-prone peso is virtually zero. So, locals are reluctant to save in pesos. Argentina’s long history of hyperinflations explains why locals hold at least $300bn in offshore banks, which governments have been failed to entice back to the country.
So, like the interest on your unpaid credit card, the debt amount just gets larger and more unserviceable. Things are looking messy all over the developing world. This year, around 66 developing countries will have to find over $4trn to service their foreign debt. EMs collectively owe $17trn of government debt, 24% of the global total. And in March, foreign investors made a mad scramble for cash, in dollars! So far, they have withdrawn about $100bn from EM bonds and shares.
While the public finances of EMs are in better economic shape to withstand external shocks (having learnt from the Asian financial crisis of 1997 and global crisis of 2007), this will not be enough to protect them as their private firms have been borrowing heavily in dollars – and the dollar is getting stronger. The dollar’s rise is the developing economy’s pain – and a commodity price slump and capital flight, when a country’s own citizens bunker their cash abroad, mean fewer of them.
How can developing countries acquire more dollars?
One way to ensure developing countries have more dollars is to stop taking them. The G20 will this year suspend collecting payments on loans to the poorest 77 countries – borrowers will of course have to make up the difference later. The IMF has also cancelled 6 months of debt payments due from 25 countries, and over a 100 countries, including South Africa, have asked the IMF for help. But without a legal mechanism to force all investors to halt debt repayment, organising a complete debt payment freeze for EMs will be very challenging.
One innovative solution, to get debt relief to many developing countries, is being offered by the World Bank’s ‘central credit facility’. Countries wanting relief would make debt payments into this pot, rather than to creditors. The CCF would be topped up by money from the World Bank or the IMF, and then lent back to the countries at low rates. Refinancing debt on affordable terms may help these countries to recover more quickly.
How quickly can developing economies get back to economic growth?
Fortunately, the financial panic has begun to subside. And for a number of reasons.
Firstly, the US Federal Reserve’s currency swaps to 14 EM central banks—including those of Brazil, Mexico and South Korea—have helped ease the dollar shortage. Plus, EM central banks have been able to relax monetary policy by slashing interest rates. This was not usual in past and is a sign of their economic maturity.
Secondly, EMs have over the years accumulated substantial dollar reserves holding over $8trn in foreign-exchange reserves. Many have enough reserves to cover all of their foreign-debt payments due this year, apart from Turkey which quickly depleted its reserves by trying to prop up the lira.
Thirdly, EM stocks are important to investors for portfolio diversification. Despite currency and inflationary risks, EM stocks are cheap. So, foreign investors are still hovering – looking for the ‘least dirty shirts’.
Fourthly, the bond markets remain attractive for raising new money. Over 20 EMs have hard-currency bonds yielding less than 4%, the kind of cheap finance only rich countries can enjoy. Even Panama, with high external debts, recently issued bonds at a yield of below 4%, in a sale that was hugely oversubscribed.
Lastly, some EMs are keen to test a monetary policy weapon which has up to now been the preserve of rich nations: Quantitative Easing (QE). Brazil has passed a ‘war budget law’ to allow its central bank to buy government bonds in what will be the EM world’s biggest ever QE programme. Next in line are the central banks of Chile, Colombia, Indonesia and Poland. This is worrying because too loose monetary policy could destabilise currencies. Plus, Brazil’s history of hyperinflation and political interference in its banks could cause even more problems down the road.
What are the prospect for Germany’s export industry?
German exports dropped by nearly 12% in March – the highest drop since records began with reunification in 1990. (But imports also fell by 5% from the previous month.) Fortunately, for Germany, its key EM export markets in south-east Asia, most notably South Korea and Taiwan (perhaps overqualified for the role of EMs), and those in eastern Europe, are the most resilient. Bigger trading economies, including Russia, China and Indonesia, also appear robust. Despite China’s long-term drop in economic growth and its high exposure to EM debt (as the developing world’s biggest creditor on the back of its Belt & Road Initiative), it is rapidly ramping up its industry. However, the recovery will be a volatile one. Economists don’t see the recovery as a classic ‘V’-shape, but rather as a ‘bathtub’.