EFIC , the Australian Government’s export credit agency, reports that emerging markets have been affected by the US sub-prime mortgage crisis. EFIC chief economist, Roger Donnelly, reports in the agency’s latest World Risk Developments (formerly Market Watch) newsletter that, finally, after a long delay, risk repricing in credit markets has rippled through to emerging economies.
According to Donnelly, emerging markets are well-placed to weather any increased cost or reduced availability of credit. But two types of countries are looking a little vulnerable as the tide turns ? those with large external financing needs and those with domestic asset price bubbles. Examples of countries in the first category include the three Baltic countries – Estonia, Latvia and Lithuania: and Hungary, Bulgaria and Romania. These countries have yawning external current account deficits in the range of 10-22% of GDP and, in some cases, unsustainable fiscal deficits. Mr Donnelly sees South Africa and Turkey as similar, if less extreme, cases.
East Asian economies are largely shielded thanks to current account surpluses and large foreign exchange reserves. However, Indonesia and Philippines do need to tap capital markets extensively to roll over existing maturing debt.
In the second category are countries experiencing domestic credit booms and asset price bubbles – some of the Gulf Arab states plus China. These countries may be insulated from external financing troubles but they can still be affected by tightening credit conditions. They may not succumb to an all-out crisis, but they could experience a downswing in their growth cycles and an upswing in debt defaults.
Swing of the pendulum
A recent worldwide glut of savings and liquidity and easy money policies among world central banks have seen too much money chasing too few assets, resulting in risk premiums falling to historic lows.
Donnelly says a swing of the pendulum back to more normal risk-taking is now on. The upswing in US sub-prime mortgage defaults in mid-June caused a swift ripple effect to the corporate bond market, forcing the shelving of some planned leveraged buyouts. However, it wasn't till 26 July that emerging market bonds were hit. On that day, the benchmark JP Morgan EMBIG index jumped almost 30 basis points, though it has since drifted in again.
Donnelly relates that the repricing of risk may have further to go. By historical standards, rewards for emerging market risk-taking are near all-time lows. The world economy is robust at present. And while many financial institutions have suffered losses on mortgage-backed securities, they are well-capitalised and well-placed to absorb these losses. So a tightening in credit conditions probably won’t threaten international growth or lead to a credit crunch.