Washington, D.C., August 4, 2015 - Emerging markets are suffering from what appears to be a "perfect storm" in recent weeks, with equities, bonds and currencies seeing declines, according to a new research note by the Institute of International Finance.
"Emerging market countries navigating harsh global economic and financial conditions must pursue strong economic policies to reduce vulnerabilities," said Hung Tran, executive managing director of the IIF. "These countries will need to articulate a reform agenda designed to improve potential future growth."
The IIF identified five factors that have combined to contribute to intensified headwinds to EM growth and prospects for financial markets:
- Heightened refinancing risk: Many EM corporations have borrowed heavily in recent years. As the IIF noted in a recent research note , EM nonfinancial corporate debt has risen to 80 percent of GDP, up from 60 percent in 2008. Much of this debt may now not be hedged effectively against currency risk. The IIF calculated that only about 30 percent of EM non-financial corporate borrowers have natural hedges (e.g., exporters with U.S. dollar revenues). For many of these corporations, revenues have slumped along with export prices of late.
- Commodity price slump: A strengthening U.S. dollar continues to contribute to the multi-year decline in commodity prices, exacerbated in recent weeks by renewed concerns about China's growth outlook. Sharp gyrations in Chinese equity prices and heavy-handed batteries of government support measures have raised concerns about China's ability to engineer a soft landing and rebalance the economy. The willingness of the Chinese government to keep moving towards a fully market driven economy has also been called into question.
- Deteriorating outlook for EM exports: With falling commodity prices already hurting many emerging market countries that rely on exports, any further weakening in China's import demand (already down over 15 percent year-on-year in H1 2015) would hit commodity exports harder still. A new IMF Working Paper focusing on network effects of demand shocks suggested that a 10 percent drop in Chinese imports could reduce the export revenue of China's trade partners (and their trade partners) by over 7 percent of GDP on average.
- Slowdown in global trade: For many reasons still under debate, world trade has slowed significantly since the 2008 financial crisis--posting only 1.5 percent growth over the past 12 months compared to a long-term annual average of 7 percent prior to the crisis. With the majority of EM countries highly reliant on trade, this slowdown has put pressure on EM earnings, corporate profits, household income and retail sales, denting growth. Slowing world trade has also made depreciating currencies less useful in stimulating export growth. Currency weakness is also putting upward pressure on inflation in some EM countries, which is likely to constrain their ability to use monetary easing to support slowing growth..
The IIF also noted that several important EM countries are facing specific challenges that have contributed to a decline in investor confidence:
- Brazil faces a political crisis that is interfering with fiscal consolidation efforts;
- Turkey faces political uncertainty about forming a coalition government or new elections, as well as politicization of economic policy-making;
- Russia faces the impact of falling oil prices and sustained sanctions; and
- South Africa faces public governance issues and labor unrest.
The IIF identified India, the Philippines and Poland as countries that are putting in place solid policy frameworks that will help them weather the storm.'
The Institute of International Finance is the global association of the financial industry, with close to 500 members from 70 countries. Its mission is to support the financial industry in the prudent management of risks; to develop sound industry practices; and to advocate for regulatory, financial and economic policies that are in the broad interests of its members and foster global financial stability and sustainable economic growth. Within its membership IIF counts commercial and investment banks, asset managers, insurance companies, sovereign wealth funds, hedge funds, central banks and development banks. For more information visit www.iif.com.' ' '