Emerging markets will face uncertain scenarios in 2016
Somewhere in the not-so-far West, on December 16, a starting gun was fired. And as 2016 begins, the shot is still echoing across the emerging world.
The trigger was pulled by the Fed, which for the first time since 2006 decided to raise short-term interest rates before the Christmas holiday. That didn’t come much as a surprise: Janet Yellen, the US central bank chief, had long hinted at her willingness to act on the back of robust economic data in America. But it still led analysts to wonder how many hikes would follow, how fast they would come and how far they would go.
The jury is still out on the pace at which the Fed will normalise monetary policy. Disappointing US and Chinese economic data published this week may induce it to take its time. But the general consensus is for America to clock in decent growth this year, which should lead the Bank to tighten further.
One thing is sure: the Fed’s behaviour is one of the major uncertainties facing emerging markets in 2016. The mere threat of a rise had already caused ructions across developing world bond markets in 2013. No such ‘taper tantrum’ was observed last December: the rise was widely expected, and much capital had already flown out of emerging markets before then (net inflows from overseas investors dropped from $285bn to $66bn last year).
But should the Fed signal anything more than a modest, gradual rise in the coming months, hot money could look to earn higher returns on US assets and rush to the exit once again. Countries with large current account deficits and low foreign exchange reserves would then be particularly vulnerable: outflows would put further pressure on their currencies, forcing them to tighten monetary policy and hurting growth.
Latin America appears to be the loser here, while Eastern Europe looks rather immune. Asia is in two minds: nations like Indonesia and Thailand are happy to see their currencies slide a little, as this helps maintain their export competitiveness vis-à-vis China (whose currency is heading downwards). But they remain wary of capital outflows.
Another crucial unknown for 2016 will be whether emerging markets are on the brink of a severe debt crisis. The question is becoming more urgent in a context where a stronger dollar will make external debt harder to repay – and where many central banks, finding themselves forced to follow the Fed in raising rates, will make borrowing in local currency more expensive.
Worries here are not really focused on public balance sheets, which by and large are sounder than they were prior to past crises. What is less clear is the true extent of private sector indebtedness: EM corporates have taken advantage of ample liquidity brought by quantitative easing to borrow overseas. The picture is made murkier still by the rise of unregulated ‘shadow’ lenders, whose fortune could have unexpected consequences for the broader financial system.
There could be further twists in the scenario. The vulnerability of some emerging markets to low oil and commodity prices will continue to stress balance sheets and prompt policy changes, themselves potentially causing social tremors (think cuts to domestic fuel subsidies or welfare payments). Geopolitical risks also abound: an escalation of tensions between Russia and Turkey, or Saudi Arabia and Iran, could cause further mayhem in the Middle East and beyond.
For all this though, the year ahead may conclude on a happier ending than 2015. Goldman Sachs, for instance, expects growth to pick up in Mexico and the CEE, with Asia more of a mixed bag. The IMF is also positive, predicting an average EM growth of 4.5 percent this year from a forecast 3.9 percent in 2015.
But deep structural frailties, from industrial overcapacity and low productivity to misallocated capital and poor education systems, remain among developing countries. By buoying commodity exporters and pulling global trade forward, China has for some time allowed the worst offenders to ignore these weaknesses. As the world’s second-largest economy tries to address its own imbalances without hitting a wall, they can no longer do so. Notwithstanding the Fed’s crucial supporting role, China should remain the EM story’s main protagonist this year.