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Emerging markets at crossroads

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Alternatives needed to conventional monetary policy.

Emerging economies and their financial markets have started to recover from the initial losses that followed the coronavirus crisis, thanks partly to record global liquidity as the world’s central banks implemented aggressive bond-purchase programmes and other measures that have improved confidence in emerging economies.

Manufacturing has recovered quicker than in developing countries as factories resumed production, led by Asia, following the easing of restrictive measures. Domestic demand has also been strong, with new orders at their highest since January 2013, and there are preliminary signs that the worst might be over for exports, thanks to strong demand for electronics and medical equipment.

Yet the road ahead is bumpy for emerging economies. Having cut interest rates aggressively – rates have fallen between 2.5 and 3.5 percentage points in Brazil, Mexico, South Africa and Egypt for instance – the scope for conventional monetary policies has narrowed significantly.

We expect rates to remain broadly on hold for most of 2021: the exceptions could be half-point cuts in Egypt, Indonesia and Romania with quarter-point reductions in India and the Philippines, while mainland China trims by another 20 basis points.

Central banks may thus switch further into unconventional monetary policies, mirroring developed countries with more quantitative-easing type measures.

However, these are likely to have some unintended consequences, including continued pressure on currencies and escalating inflationary pressures. Additionally, despite the widening output gaps, supply-chain disruptions – particularly in the food sector – could also push up prices given food comprises a high share of consumer spending in emerging markets compared with developed countries.

The lack of conventional monetary easing will likely mean tighter financial conditions. Government borrowing has remained high because the fiscal stimulus – including support for households and companies hit by the pandemic – led to a sharp deterioration in public accounts. Total public-sector borrowing could be around 9 per cent of emerging-market GDP, or $2.7 trillion, for the final nine months of 2020 and a return to more sustainable levels seems unlikely in 2021.

Egypt’s gross borrowing requirement could exceed 28 per cent of GDP next year with Brazil and South Africa also big borrowers.

Meanwhile fiscal gaps will be particularly large in Central and Eastern Europe, Middle East and Africa, led by South Africa, where the budget deficit is expected to reach 11.7 per cent of GDP, and Saudi Arabia at 8.7 per cent next year. Brazil could also see an 8.8 per cent deficit and Argentina 6.0 per cent.

The deterioration in emerging-market fiscal accounts is likely to continue, with deficits remaining large for years to come. Ample liquidity will buy some time, but developed markets are also borrowing aggressively and there is probably only so much excess savings globally. Emerging nations need to improve their risk premium to attract capital.

Emerging markets are thus at a cross-roads and policymakers face hard choices. One option is fiscal consolidation (like in Saudi Arabia) and/or monetary tightening (following Turkey and Hungary) to help with capital flows and prevent currencies from weakening further. Another is continuing the loose fiscal policies and unconventional monetary policy, hoping for a growth rebound and benign inflation. Alternatively, fiscal reforms could improve investor confidence.

HSBC’s flagship GEMs Forum – virtual this year – runs from 6 to 30 October with over 40 macro, thematic and sector panels and discussions plus meetings with about 100 global emerging market companies.

First published 4 October 2020.

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