On the 10th of October the IMF warned of a possible incoming emerging market crisis, though this warning may be too late given the collapse of several currencies – Turkey, Iran, Argentina, and Indonesia and Pakistan to name a few – over the last few months. The causes of this can be summarised by two key points; changes in the global geopolitical climate, and inherent structural issues within emerging markets.
American foreign policy
Based on the current stream of news reports, some would cite the ongoing trade war between the United States and China as the primary cause of the crisis, a direct result of the US’s aggressive foreign policy. Trump’s administration views conventional international economics as a zero-sum game, and therefore in attempts to aggressively skew conditions to obtain short term lopsided gains at the expense of others. The US has also been willing to weaponise international trade, for example, imposing tariffs on Turkish exports on steel and aluminium to pressurise Ankara to release an American pastor, the result of which precipitated the large devaluation on the Turkish Lira.
Raised interest rates in the US and emerging market structural issues
The most significant factor which has impacted emerging markets is US Federal Reserve raising interest rates for the 8th consecutive time. Rate increases in the US invariably effect emerging markets, as assets are reallocated outside of emerging markets. There are structural issues with several emerging markets which has left them particularly vulnerable to the rise in US interest rates. For example, an over reliance on foreign currency and addiction to borrowing cheap dollars. This has particular relevance to Indonesia as the Indonesian state pushed its state-owned companies to borrow to fund large infrastructure projects. State-owned utility company PLN recently issued $2bn in dollar-denominated bonds and borrowed from international banks. PLN’s debt and purchasing power is denominated in dollars, but their revenue is paid in rupiah which has depreciated by 9% in 4 months.
Nations such as Argentina, Turkey and Indonesia are heavily reliant on short term dollars have therefore been left vulnerable to the change in interest rates. Poor political decisions have exacerbated this issue by centralising monetary policy. President Erdogan for example has responded to US tariffs and free-falling Lira by keeping interest rates low as possible – in part due to the indebtedness of the private sector – keeping the lira cheaper while euros and dollars become more expensive. Effectively this means debt in foreign currency is more difficult to repay and leads more foreign borrowing, therefore creating an inescapable cycle.
Generally, emerging markets have gone on a borrowing spree. The total amount of emerging market debt in 2007 was $21tn, which grew to $63tn in the span of a decade (a jump from 145% of GDP to 210% of GDP). Non-household and corporate borrowing of foreign currency debt (yen, euros and dollars) amounted to $9tn in 2017. “China, India, Indonesia, Malaysia, South Africa, Mexico, Chile, Brazil and some Eastern European countries have foreign-currency debt between 20-50% of GDP.”
Argentina and the IMF
Argentina is struggling significantly, their interest rate hike to 60% has stifled growth and worsened the debt burden. The rate of inflation currently sits at 31% which is expected to climb to 40% by the end of the year. President Macri has turned to institutional support from the IMF, much to the displeasure of the electorate (the IMF loan in the 90s caused a $135bn default). The IMF is set to provide a $50bn stimulus, at the cost of unpopular austerity and harsh cutbacks on public services. The hope is that foreign investors will regain confidence in the Argentinian economy, deficit targets and repayment targets can be met, and stimulus will be provided to the struggling economy.
High returns on local high yield currency debt was previously “attractive to foreign investors India, China, Malaysia, Indonesia, Mexico, Brazil, South Africa and Eastern Europe. But weakening currencies may drive them to exit, hurting all assets.” $1tn was divested from emerging markets in the past year – a flight to safety of sorts. Despite, the wider trend seeing private investors divesting, we are seeing some flow looking at opportunistic and distressed acquisitions in certain emerging markets, particularly Turkey.
To conclude, the current emerging markets crisis shows no sign of abating, with short termism, the over reliance of short-term dollar funding, and increasing personal and corporate debt. Within this midst, there are opportunities to acquire distressed assets with investors looking at Turkey and Indonesia. However, one must tread carefully given the continued political instability and pressure on the currency.