Emerging countries have continued to recover since the beginning of the year, although the recovery remains fragile. Household confidence indicators are lagging behind those of business sentiment, illustrating the constraints on domestic demand: the pandemic risk persists, inflation is accelerating, and governments are facing rising financing costs, which reduces their fiscal manoeuvring room. Despite buoyant foreign trade, the horizon is not clear enough yet for investment to rebound. Fortunately, the vast majority of central banks have been maintaining a proactive stance so far, despite inflationary pressures. But monetary policy is bound to tighten across the board.
In their spring outlook, the IMF economists expect to see a multi-speed (and incomplete) recovery of the global economy in 2021. Indeed, speed is the key word for 2021 because the emerging countries are racing against time on several fronts. In our eyes, the greatest short-term risks are linked to the race between the rollout of vaccinations and the spread of the pandemic, and between higher food prices and the partial catching-up of revenues for low-income households. If this divergence persists, we could see a rise in social risks, which may have a much more destabilisation capacity than financial risks.
The significant increase in US Treasury yields in recent months has not yet led to a widening of the spread between US Treasuries and the global emerging bond market index. This index covers USD-denominated traded bonds & loans issued by sovereign and quasi-sovereign borrowers in a large number of developing economies, whereby a distinction is made between investment grade (IG) and the lower quality speculative grade (SG) issuers. The absence of spillovers coming from the United States is a relief. Admittedly, emerging market yields have moved higher, in line with US yields, but they have been spared from a spread widening, which would have made financing conditions even more onerous. Things have been different in the past
Almost a year ago, the pandemic triggered a financial shock that shook the emerging countries. Since then, monetary and financing conditions have largely returned to normal. Portfolio investment even soared to record levels in the second half of 2020 in a context of a massive support from the Fed. Under this environment, for the majority of the major emerging countries, government borrowing costs in local currency are equal or lower than they were at year-end 2019. And yet swelling fiscal deficits have driven up public debt to unprecedented levels. The low cost of government borrowing can be attributed largely to the widespread easing of conventional monetary policy via policy rate cuts, and to the securities purchasing programmes adopted by many EM central banks
As the new year gets underway, emerging countries are benefiting from a combination of favourable factors for a recovery (catching-up movements in foreign trade, a weak dollar, rising commodity prices, and domestic financing costs that are lower than pre-crisis levels). Yet lots of uncertainty and threats remain: the rollout of vaccination campaigns, the risk of a surge in insolvency cases among the poorest countries, despite financial support from international institutions and official creditors, and a rise in non-performing loans in banking systems as of 2021. The main risk in the medium term is the combination of a probable loss of growth potential due to the pandemic and the private sector’s record-high debt burden.
The recovery in economic activity that began at the end of the spring continued through the summer, with China leading the way, and oil and metals prices have picked up. But doubts are emerging as the pace of the recovery seems to be slowing, as reflected by exports recent loss of momentum. Above all, there are currently worries regarding the persistence of the pandemic and the risk of lockdown extensions or even new lockdowns in several countries. There are, however, some factors of support: continued easing of monetary policies, market tolerance of rising budget deficits and a reduction in the debt of the most vulnerable countries by official lenders. However, the leverage of those factors should not be overstated.
Since mid-April, calm has been restored in the financial markets of emerging economies. In most countries, exchange rates have begun to appreciate again, while money market rates and bond yields have eased thanks to the general easing of policy rates and greater use of quantitative easing by national central banks, external financial support, and the return of portfolio investment. As is often the case, the equity markets have exuberantly – and prematurely – welcomed this return to normal. Indeed, the economic recovery seems to be taking shape, but it remains very fragile.
Emerging countries have been severely affected by the COVID-19 pandemic even though the official number of confirmed cases and deaths (excluding China) is still low compared to the figures for the developed countries. A wave of slowdowns and recessions is only just beginning, and the economic fallout will probably spread beyond 2020, because the real shock (shutdown of business due to confinement measures) is compounded by a financial shock and commodity price shock. Capital outflows and the freeze on bond issues in international markets increases refinancing risk in US dollars. Preventative safety nets are being set up to reduce defaults, but the solution for the most vulnerable countries is probably a sovereign debt moratorium or a debt relief.
