Emerging markets (EMs) have for long been at pains to contain the financial turmoil that struck them amid the US Federal Reserve’s focus on tightening the financial conditions. To tame higher prices, the Fed is embarking on its most aggressive series of interest-rate increases in two decades, which helps drive up the dollar and push down other currencies. The fallout from a mix of external shocks and mounting financial troubles are washing over low- and middle-income countries, creating perhaps the biggest confluence of challenges since the 1990s, when a series of rolling crises sank economies and toppled governments.
Turmoil fed by rising food and energy prices is already gripping places such as Sri Lanka, Egypt and Peru. A post-pandemic surge of inflation is a recipe for strain in countries that need US dollars for energy, medicine and food imports. Food costs account for about 40% of consumer spending in places like sub-Saharan Africa, more than double the share in advanced economies. The current dynamic can trigger fits of panic among international investors and sudden flights of capital from the countries’ most exposed.
Sri Lanka is seen as a prime example of how shortages of food and fuel can spill over into violent street protests and destabilise an unpopular government. The South Asian nation defaulted on its foreign debt in May for the first time since achieving independence from Britain in 1948. A handful of other nations, including Pakistan, Tunisia, Ethiopia, Ghana and El Salvador were in danger of following suit, according to Bloomberg Economics. EM stocks have fallen below their average valuations of the past 17 years. With a $5tn stock rout and 15 months of capital outflows, emerging markets are at an advanced stage of pricing in the risks. Still, the risk of deeper losses remains, especially if China’s economy slows further or the Fed turns more hawkish.
The combined equity values of the 24 nations classified as emerging markets by MSCI Inc has fallen $4tn since a peak in early 2021, while Bloomberg gauges of dollar bonds and local-currency debt have lost $500bn each from their highs. Political and business leaders gathering for the World Economic Forum (WEF) met on Monday against a backdrop of inflation at its highest level in a generation in major economies including the United States, Britain and Europe. International Monetary Fund managing director Kristalina Georgieva said the war, tighter financial conditions and price shocks – for food in particular – have clearly darkened the outlook in the month since, though she is not yet expecting a recession.
The World Bank mobilised a $170bn crisis-response package in April, more than the $157bn spent for its initial Covid-19 response. More countries entered rescue talks with the IMF. The deeper problems in the EMs stem from the excessive financialisation of the global economy that has occurred since the 1990s. The resultant policy dilemmas – rising inequality, greater volatility, reduced room to manage the real economy – are seen continuing to preoccupy policymakers in the decades ahead. Sure, Western central banks will no longer be pumping easy money. So, emerging economies must seek investment cash at home.
Without a significant home-grown investor base, supported by futuristic policy initiatives and structural reforms, countries risk a return to the old boom-bust cycles of the 20th century. And part of the challenge will be to rebuild macroeconomic buffers that have been depleted during years of fiscal and monetary stimulus.
