Emerging countries have recently faced a series of unexpected and severe shocks that will significantly dampen their economic performance in 2022. Global inflation has increased due to rising commodity prices and world supply disruptions resulting from the conflict in Ukraine. The lockdowns in China’s industrial regions during the spring have aggravated supply problems and further worsened the global economic outlook. Moreover, monetary policies have tightened in most countries, while external financing conditions have also deteriorated due to the weakening in global investor sentiment and US monetary policy tightening. Emerging markets have already faced a bout of large capital outflows since the beginning of the year
Over the past few weeks, Central Europe has experienced a spike in Government bond yields. Five-year yields have surged respectively by 338 bp in Poland, 331 bp in Hungary, 350 bp in Romania and 216 bp in Czech Republic since January 2022 and are at present similar to 2008 levels. The trend is also the same for 10-year yields. The recent move can be explained to some extent by markets’ overreaction as regards to the relatively high exposure of Central European countries to Russia in terms of exports and energy supply. Moreover, their geographical proximity with Ukraine and Russia have contributed to markets’ perception of higher geopolitical risk. In the meantime, monetary policy tightening, a consequence of higher inflationary pressures (respectively +16
Emerging countries are now facing another major shock whereas the post-pandemic recovery has remained fragile. The war in Ukraine will impact emerging countries through its negative effects on foreign trade, capital flows and, above all, inflation. The indirect effect of soaring global commodity prices on inflation households’ purchasing power may be particularly severe, and affect mostly low-income countries in Africa, Central Europe and the Balkan region. In spite of these gloomier prospects, we do not expect a broad-based worsening in sovereign and external solvency in emerging countries in the short term. However, a few governments, especially in Africa and the Middle East, may rapidly experience payment difficulties.
For emerging economies, the balance prospects/risks has been deteriorating since end-2021. For 2022, a bigger than expected growth slowdown is very likely, sometimes with social instability as already seen in Kazakhstan. Over the last three months, Turkey has experienced a mini financial crisis again. Monetary and exchange rate policy is betting on exports and investment to support growth and rebuild the major economic balances over the medium term, albeit at the price of short-term financial instability. This is a daring gamble that could force the authorities to introduce genuine foreign exchange controls instead of the incentive measures they have implemented so far.
The recovery in emerging economies since mid-2020 has been accompanied by a tightening of monetary policy in Latin America and Europe but not in Asia so far (except South Korea). The main reasons for this lie in the level and dynamics of inflation. Inflation is strong and accelerating in Latin America and Europe, more modest and still contained in Asia
Emerging economies have faced mounting inflation pressures since the beginning of 2021. Headline inflation has continued to accelerate over the summer (except in Asia), primarily reflecting the rise in food and energy prices and weaker currencies against the USD. However, core inflation has also accelerated across the board. As a result, a growing number of central banks in Latin America and Central Europe have started to raise their policy rates. In Asia, inflation has remained low (North Asia) or has levelled off (India), allowing central banks to stay accommodative. So far, central banks engaged in a tightening cycle have increased their policy rate cautiously; even the more reactive ones (in countries such as Brazil and Russia) have remained behind the curve (i.e
The recovery in emerging countries remains fragile. Several economies in Asia and Latin America went through an air-pocket in Q2 2021. The emergence of Covid-19 variants has triggered new waves of the pandemic resulting in production stoppages, which have been temporary so far but which are eroding business confidence. Companies are also struggling with supply-side constraints, including supply-chain bottlenecks and energy shortages, which are contributing to fueling inflation and indirectly straining household confidence. Lastly, the Chinese economy is a source of concern with its sluggish household consumption and with the construction and real estate sectors in great distress
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.
