By William Rhodes
Don’t be fooled. The high levels of volatility in emerging markets and sharp, sporadic pressures on a range of currencies, including those of Argentina, Mexico and Turkey, which holds elections on Sunday, are the opening salvos in a new period of mounting risks and uncertainties.
The tensions and challenges in developing economies that will come into ever-clearer focus in coming weeks and months are not being sufficiently recognized to provide assurances that crises will be handled well – or that contagion across the financial system will be easily contained. The financial environment that is rapidly evolving for emerging markets results from a combination of assorted factors, which could amount to a perfect storm.
A considerable number of countries have rising current account deficits – such as Brazil, India, Indonesia, Turkey and South Africa. Then, sovereigns and corporations in many emerging markets – in Latin America, Africa and, notably Turkey – have taken advantage of the abundance of global liquidity to borrow heavily in foreign currencies.
Debt-servicing problems will rise as the U.S. Federal Reserve continues to reduce its balance sheet and makes at least two further interest-rate increases in the next six months due to American inflation advances, GDP surges, possibly to over 4 percent, and unemployment levels at near record lows.
The Fed chaired by Jerome Powell knows its actions will add pressure to emerging-market currencies, but it has not allowed such considerations to influence it in the past and it will not do so now. The European Central Bank under Mario Draghi will follow the Fed’s lead and plans to curb its quantitative easing, but it will adjust more slowly than the U.S. central bank, not out of emerging-market concerns, but due to slowing growth in much of the euro zone and from the new, and less predictable, governments of Italy and Spain.
The pressures in markets will be compounded by the actions of too many institutions and individuals in the financial community who failed to learn the lessons of the last global crisis. In their reach for yield they have continued to make short-term gains their paramount objective and now they are set to be burned.
Too few of these investors have adequately taken into account the core change in the nature of Western industrial economies from years of high unemployment, low productivity gains, sluggish growth, and record-low interest rates. The major economies, led by the United States, are returning to more normal economic conditions – at last – and the tighter monetary conditions will increasingly expose the multitude of vulnerabilities that abound in many parts of the financial markets.
At the same time, China needs to confront its own financial challenges and I anticipate that now that President Xi Jinping has consolidated power he will be ready to see somewhat lower annual economic growth. This is essential to getting a handle on a debt-to-GDP level above 250 percent, borrowing excesses of state-owned enterprises, municipalities, housing developers and others, and the large resulting exposures of financial institutions, particularly in the shadow banking area.
Slower growth in China will also hurt many commodity-exporting countries. Moreover, uncertainty surrounds prospects for international energy prices. Increases will add pressures to oil-importing emerging markets and their currencies. It needs to be remembered, for example, that Venezuela, once a major oil exporter, has so mishandled its production capacity that it is virtually out of the game.
Politics will have a profound impact and few governments will be positioned to take the tough actions required to head off major difficulties. Argentina’s President Mauricio Macri made the mistake of pursuing what he called a “gradualist” reform program when he took office in late 2015. Now, still well ahead of national elections at the end of October 2019, he has decided to act more forcefully, agreeing to a $50 billion loan from the International Monetary Fund with budget disciplinary conditions attached.
But Turkey, Mexico and Brazil all have national polls this year and the outcome of each could produce policy paralysis.
Elections this weekend in Turkey start the ball rolling. Whatever the outcome, the impact on international confidence and inward investment flows is likely to be negative. If President Tayyip Erdogan wins big, then a full-blown dictatorship seems possible; if he fails to secure a majority in parliament, then the door will open to bitter political clashes.
Mexico faces its own confusing political prospects in elections on July 1. Veteran socialist Andrés Manuel López Obrador and his followers will probably sweep to power because of the failure of the current regime to respond to rising public demands for a serious attack on corruption. As in Brazil, Malaysia, South Africa, and Italy as well, corruption has become the dominant issue in politics and establishment leaders are being given the boot.
Under the Mexican system, the presidential and parliamentary elections are in July, but the presidential victor only takes power in December, while the new parliament is not sworn in until September. That means there could be up to six months of lame-duck, do-nothing, leadership in Mexico – a period that will see the country face unprecedented trade protectionist pressures from its northern neighbor, starting with the United States suspending NAFTA negotiations.
Who will win the presidential election in Brazil is anyone’s guess since the most popular politician in the country, Luiz Inacio Lula da Silva, was found guilty of corruption and is now jailed. Indeed, it is rare to see so many elections ahead where the results are so unpredictable.
Rounding out the perfect storm scenario demands a focus on the White House. Threats to the global trading system have not been as great since the 1930s. Then, the beggar-thy-neighbor actions had terrible consequences. The first shots in a series of trade wars between the United States and its trading partners have now been fired. More will follow.
Exports are the lifeblood of most emerging-market economies. Actions by Washington to curb those exports could exacerbate tensions in global markets. All countries and all investors will be the losers.
Compliments of William R. Rhodes Global Advisors, a member of the EACCNY