This is the fifth column in a series from Heard on the Street on the end of zero interest rates.
When the Federal Reserve starts raising interest rates, emerging markets often start to subside again: their borrowing costs rise, their currencies fall, and to make matters worse, slower US growth dampens demand for their products. Will this period coincide with the end of the zero-interest era?
Much remains uncertain – not least the development of oil prices and the war in Ukraine – but some preliminary observations are possible. First, some of the major emerging markets that have been squeezed by previous Fed rate-hiking cycles – South Korea in the late 1990s and China in late 2015 – now look much better isolated. Large oil or gas importers with high foreign debt are likely places to avoid. But some of the worst offenders in this regard, notably Turkey and Argentina, are already blacklisted by foreign investors.
While it’s still not clear if or where problems might arise this time, understanding how past crises came about can help investors know what to look out for. Debt and currency crises in emerging markets typically occur after a combination of the following factors: financial liberalization, large capital inflows at a time of low global interest rates, a deteriorating balance of trade, and a boom in domestic investment – particularly in relatively unproductive assets such as housing.
The Asian financial crisis that erupted in 1997 after the low-interest years of the early 1990s was a textbook case: Yield-hungry global investors poured money into fast-growing Asian economies like Thailand and South Korea, helping fund huge real estate and investment booms. Partly as a result, these countries found themselves with highly valued currencies, domestic resources tied up in asset bubbles, and reduced export competitiveness. This made them vulnerable to capital flight after the global interest rate environment changed. Further back, in the late 1970s and early 1980s, a similar story unfolded in Latin America.
More recently, China’s mini-debt and currency crisis in 2015 and 2016 was largely the result of domestic deleveraging efforts, but it followed a huge real estate investment boom and was exacerbated by earlier phased moves to open up the capital account and the beginning rate-hike cycle the fed
Today, two of the largest and most important emerging markets – China and South Korea – look well isolated. China tightened control over funds leaving the country again after the 2015 crisis, and both countries have enormous war chests of foreign exchange reserves. Korea is a major exporter of something the rest of the world can’t get enough of: advanced semiconductors. China could increasingly benefit from conducting its oil trades with partners like Russia and Saudi Arabia in its own currency, and to some extent from demand for its currency and the sovereign debt of other autocratic states.
A potential trouble spot is India, the world’s third-largest crude oil importer after China, and US credit rating agency Fitch noted in November that its sovereign debt burden of around 90% of gross domestic product is the highest among emerging markets in the BBB rating range. The total debt burden of 173% of GDP last September is also high, according to the Bank for International Settlements.
But India’s roughly $620 billion in foreign exchange reserves is sizeable relative to its economic weight, and its external debt is relatively small — about 20% the size of the economy as of June last year, according to the Reserve Bank of India. According to the World Bank, this compares to around 29% for all low- and middle-income countries in 2020. Turkey and Argentina, two countries that have recently run into debt problems, both hit over 60%. However, if oil prices continue to rise, India will be forced to make some tough policy choices. If not, it might weather the current storm without massive fiscal damage or a brutal series of growth-damaging rate hikes of its own.
Rising US interest rates usually mean trouble abroad. That will likely be the case this time as well, but some of the largest stranded whales from the last tidal wave are swimming much more comfortably now. Problems are likely to arise somewhere new.
write to Nathaniel Taplin at firstname.lastname@example.org
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Appeared in the print edition of March 24, 2022 as “Emerging Markets Brace for Rate Crisis”.
https://www.wsj.com/articles/will-the-fed-sink-emerging-markets-again-11648037973?mod=rss_markets_main Will the Fed sink emerging markets (again)?