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Which Emerging Markets Face Challenges?

By March 5, 2014 No Comments

International trading partners and export markets are discussed in this article

What is Happening with Emerging Markets?

March 5, 2014

Ferdinando Guerra, International Economist, Kyser Center for Economic Research at LAEDC

Financial troubles have returned to emerging markets over the past few months. Last spring, the hint of tapering monetary policy or slowly reversing quantitative easing (QE3) by the Federal Reserve created havoc in emerging markets. However, this time around it is actual not potential U.S. monetary policy along with a number of other factors that is rocking emerging markets. First, let’s quickly re-visit what has transpired over the past few years. Since 2008, aggressive U.S. monetary policy has pushed interest rates down and sent investors into emerging markets looking for higher returns. This arrival of easy money strengthened emerging markets currency markets and financial markets as well as led to unsustainable economic macroeconomic policies. Now, the Federal Reserve has begun to reduce its long-term bond purchasing program, which will translate into higher interest rates and reversal of capital flows. So what are the other key factors that are causing so much turmoil in emerging markets?

Well, first and foremost it is weaker economic data out of China over the past couple of months that has raised big concerns about the potential direction of the global economy. Most importantly, any signs of furthering weakness from the Chinese economy would cause many investors to becoming increasingly alarmed about a so called “hard landing” in China. Many experts have had the fear of a sharp slowdown in China for the past three years. This would of course have significant ramifications for the entire global economy particularly those economies that are dependent upon demand from China.

Second, a currency crisis in Argentina really propelled all of this into motion and rattled markets back in January. The Argentinean peso lost 15% of its value in just one day in January and ended January depreciating by nearly 20 percent. The situation was worsened at the time as the government halted its interference in the currency market in order to prevent a decline in foreign reserves (particularly U.S. dollars, which Argentina is in short supply of). However, the government has reversed this policy and it has resulted in a stabilization of the peso in recent weeks.

A third  key reason for this trouble with emerging markets is related to politics. We currently have political scandals and/or unrest in Turkey, Thailand and of course most recently in Ukraine along with big elections this year in India, Brazil and Indonesia. In my opinion, this presents the perfect example of how you cannot separate economics from politics. Political risk does play an instrumental role in determining economic stability and vitality.

Some key emerging markets have real core issues that will have to be addressed. Let’s start with the most fragile. They are India, Turkey, Indonesia, Brazil and South Africa. They all have weakening economic growth rates, high inflation, fiscal deficits, and political uncertainty due to either parliamentary or presidential elections. Other trouble areas include Argentina, Venezuela, Hungary and Thailand, which have similar issues. Another key problem for some of these emerging markets is related to the commodity boom that we have seen in recent years. This boom is no longer evident and they have felt the consequences due to a drop in demand and prices.

Next, we must of course address the situation in the Ukraine. The crisis in the Ukraine could potentially have real implications for the global economy and could most negatively impact the economies of Ukraine, Russia and Europe. The main economic and financial concerns of this crisis include the following:

Ukraine’s Economy has already been in a recession since mid-2012, which prompts the question; What will happen to GDP, unemployment, inflation, trade, foreign direct investment (FDI) and huge debt issues?

  • Russia’s Economy only experienced 1.3% growth in 2013, leading to a strong possibility of a recession as trade, FDI, energy, currency problems and potential sanctions  impact Russia’s economy.
  • Europe’s Economy is just coming out of a recession, and relies on a substantial amount of natural gas coming from Russia via pipelines through the Ukraine, two-way trade, FDI, etc.
  • Global Economy and financial markets could be impacted as Russia is a major supplier of oil, a BRIC country and most importantly Ukraine is one of the top exporters of corn and wheat – so a halt in exports could translate into higher food prices globally. This has already impacted currency markets including the Japanese Yen which is looked to as a safe-haven currency in times of crisis.

The good news is that this all added up does not necessarily mean a major emerging markets economic and financial crisis is right around the corner. In fact, any risk of a big crisis remains low due to many factors. Most of these troubled emerging markets have flexible exchange rates, a large amount of foreign reserves, solid banking systems, and low debt ratios. Many of these same economies already lived through financial crises in the past and have learned valuable lessons from those experiences, which will make it less likely for it to happen today. Of course, we could see one or two emerging markets have substantial crises, but this will not translate into a global crisis.

For purposes of our Southern California regional economy I believe we need to keep a close eye on Thailand, Indonesia, India and Brazil. Thailand and Indonesia are two of our top trading partners. Meanwhile, every year that passes both India and Brazil are becoming ever-more interconnected with our regional economy. In fact, we have seen India quickly move up the rankings of our top trading partners over the past few years. Brazil and India both represent some of our top export markets. Also, all of these countries will become larger sources of foreign direct investment into our region in the years to come. In addition, almost all of these economies have become vital players in global supply chains. Thailand is the perfect example, as we saw the implications of a supply shock on our computer and auto industries just a couple of years ago as a result of devastating flooding.

Finally, and most importantly, not all emerging markets are in a bad position and all of these economies still present excellent opportunities in the medium to long term for the reasons you are very familiar with; growing populations, urbanization, industrialization, a burgeoning middle class, and for the most part sound economic policies. Ultimately, the long term trajectory of economic growth will be determined by whether or not these countries implement structural reforms and whether or not they can remain politically stable. Over the shorter term, the global economy should be able to overcome this turbulence and experience stronger growth in 2014 due to more robust growth in the advanced economies, particularly in the U.S. and Europe. However, if the situation in Ukraine deteriorates significantly in the coming days we could see a very different scenario. Specifically, a prolonged and severe crisis would negatively impact the Russian economy as well as any type of recovery in Europe mainly due to the impact on trade, business, investment and energy ties (natural gas and oil).