EFIC, the Australian Government’s export credit agency, reports that emerging markets are for the most part well-insulated from the current flight to safety and liquidity in international markets.
EFIC chief economist Roger Donnelly reports in the agency’s latest World Risk Developments bulletin that strong fundamentals immunise most emerging markets from outright crisis à la 1997-98, though growth will suffer if the US or Japan, or both, go into recession.
“In contrast with a decade ago, most emerging markets now have floating exchange rates that if anything are under-valued rather than over-valued, larger foreign exchange reserves, lower shortterm foreign debt, and external current account surpluses rather than deficits,” Donnelly says.
“As net capital exporters with big foreign exchange buffers, they have little need to tap international markets for liquidity at an unfavourable time like the present.”
He points out a Bank for International Settlements’ September report noted the rise in emerging market sovereign credit spreads has not been as sharp as for similarly-rated industrial country corporate credit.
Reasons appear to include strong fundamentals reflected in a continuing stream of ratings upgrades that outnumber downgrades, and some positive technical factors including large coupon and amortisation payments, expected debt buybacks and a low level of sovereign issuance.
Emerging market shares and currencies have outperformed their industrial country counterparts. The MSCI emerging markets share index has risen since the start of July, while the S&P has fallen.
According to Donnelly, this resilience has led some market analysts to suggest the emerging market asset class has now come of age and can provide a safe haven in the current turbulence.
Even so, emerging markets are not totally shielded from the turmoil for at least three reasons:
- Asset prices could deflate significantly as carry trades are unwound. The carry trade phenomenon of borrowing in low-yield currencies such as yen and Swiss francs to invest in high-yield currencies has been a significant driver of recent asset market rallies in emerging economies
- Emerging market asset holders in undemanding regulatory and accounting regimes could delay recognition of losses sustained on financial instruments linked to the US sub-prime debacle
- Falling home building and weakening consumption in America as a result of the sub-prime crisis are increasing the chance of a full-blown recession in the US. Worse, recent indicators suggest Japan, the world’s No 2 economy, could also be headed for recession. Such downturns could represent a significant GDP setback for many emerging economies given their significant trade exposure to the US and Japan. Fortunately, many have the capacity to cushion the blow by stimulating their domestic economies, due to current account surpluses. Markets susceptible to the receding tide of credit are those with large external financing needs, predominantly in Central and Eastern Europe, and those with richly-priced asset markets, including China and some Gulf Arab states. There is also some concern about emerging market companies now borrowing offshore extensively, which could be squeezed by the combination of increasing credit spreads and sagging exports
Other World Risk Developments highlights:
- Booming trade is stretching shipping and port capacity worldwide, resulting in bottlenecks, delays and outsized freight prices. Soaring Chinese demand for coal, iron ore, soya and the like is stretching capacity in the trans-oceanic bulk shipping market and causing congestion at Australian and Brazilian ports.
- In Fiji, the military-backed government’s re-imposition of a state of emergency has heightened tensions, and dimmed hopes of a swift return to democracy and economic stability
- Thailand’s referendum has failed to resolve political crisis, as the 58% yes vote in favour of a new constitution suggests a deeply divided electorate
- Mining companies face tougher terms in Indonesia as the national government is reviewing existing mining contracts and has warned companies to prepare for contract revision
- The Democratic Republic of the Congo’s Justice Ministry’s revocation of a mining license held by the Central African Mining and Exploration Company (CAMEC) has investors worried other contracts and licences could follow suit