The surging US dollar is piling stress on to emerging economies already reeling under the twin shocks of the coronavirus outbreak and the plunge in global oil prices.
Across the emerging world, governments are taking rapid action to support their economies as financial conditions tighten under the strain of dollar outflows.
Non-resident investors have taken $78bn out of emerging market stocks and bonds in the two months since markets woke up to the coronavirus crisis on January 21, according to the Institute of International Finance — more than three times the amount of cross-border outflows in three months after the outbreak of the global financial crisis in September 2008.
This, said Robin Brooks, the IIF’s chief economist, amounts to a “sudden stop” in funding and will cause a sharp tightening in financial conditions, leaving households, businesses and governments starved of credit.
The US Federal Reserve sought to ease the stress on the global circulation of dollars on Thursday by setting up swap lines with eight central banks in developed and emerging economies including those of Brazil, Mexico and Korea, providing them with dollar liquidity of up to $60bn each for at least six months.
It added to the Fed’s enhanced liquidity provisions for G7 central banks announced on Sunday, completing an almost identical rerun of its measures to provide liquidity during the global financial crisis of 2008-09.
But financial conditions have changed dramatically for many emerging economies in the decade since the last crisis.
“The dollar is going to strengthen more and these economies are going to be squeezed,” said Richard Kozul-Wright, director of globalisation and development strategies at Unctad, the UN’s trade and development agency.
Countries in sub-Saharan Africa are among the most exposed, after gorging on external debt in recent years; Mr Kozul-Wright said they “are not going to be able to service any of these debts”.
On the positive side, many governments have built up foreign exchange reserves, a valuable buffer against stress, and succeeded in reducing inflation and currency volatility. This has made investors more willing to hold their debt — at least until the past week, when many have been selling whatever they can.
Emerging market policymakers have been quick to ease financial conditions this time around.
Brazil was the latest to announce a surprise interest rate cut, taking its policy rate down half a percentage point to 3.75 per cent on Wednesday night, below the rate of inflation. At least 22 emerging market central banks have cut rates this week alone, including a 3 percentage point cut in Egypt and cuts of 1 percentage point or more in Ghana, Turkey and Vietnam.
William Jackson, chief emerging markets economist at consultancy Capital Economics, said it was positive that central banks had prioritised supporting output growth through rate cuts without worrying about the stress on their currencies, many of which have suffered deep falls this year.
“The monetary policy response has been very quick, not just with rates but with various measures to make it easier to access liquidity and repay debts,” he said
On the negative side, analysts say monetary policy may be of little help, and many countries have run up big budget deficits over the past decade, making it harder to respond by boosting public spending.
For example the external debts of sub-Saharan African countries have risen steeply, from $235bn in 2008 to $634bn last year, according to the IMF, up from 21 per cent of GDP to 36 per cent.
And monetary policy, Mr Jackson said, can do little to tackle the threat posed by coronavirus to poor communities living in overcrowded conditions.
“In that environment, how do you enforce social distancing?” he asked. “These are countries where the welfare state and health services are very weak and where the risk is that the disease could spread very quickly.”
Many big emerging economies will struggle to deliver anything like the level of public spending they used to tackle the crisis of 2008-09.
“In Brazil, South Africa or India, they don’t have any fiscal room whatever,” said Bhanu Baweja, chief cross-asset strategist at UBS.
Ghana on Wednesday sought support under emergency packages announced this week by the IMF and the World Bank, after its finance minister told parliament the government might not meet its targeted 2020 budget deficit equal to 4.7 per cent of GDP.
The IMF on Monday promised to provide $1tn of loans to help its members deal with the coronavirus pandemic, including $50bn for emerging economies and $10bn for low-income countries at zero interest rates. The World Bank promised an additional $14bn in fast-track finance to help companies and governments tackle the outbreak.
Even with all these measures, Mr Baweja said, “the bigger issue is that in six months we may wake up and find we are out of bullets”.
“The real question is whether this is an acute shock or a prolonged one. If it’s acute, that’s very bad. But if it is prolonged, the likes of Brazil, South Africa and India could be pushed into a very deep crisis,” he added.
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