Emerging Markets Face their Financial Crisis.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
In a remarkable turnaround, foreign investors are estimated to have pumped over $35 billion into emerging market (EM) stocks and bonds in March, the highest monthly inflow in nearly two years, according to the Institute of International Finance. One of the biggest beneficiaries is Latin America, which for months had been shunned by investors. The region took in $13.4 billion, with equities in even crisis-hit Brazil receiving over $2 billion.
But is this the beginning of an enduring rally or is this “hot money,” which can change direction without notice, about to get cold feet again?
“Over the past 15 years there has been a very large increase in the presence of foreigners in domestic equity, bond and deposit markets of developing countries,” says Dr. Yilmaz Akyuz, the chief economist of the South Centre, an intergovernmental organization of developing and emerging economies representing 52 countries, including four of the BRICS nations (Russia excluded). Akyuz was speaking at a briefing of delegates at the UN’s Geneva headquarters.
This influx of foreign funds may seem like a blessing until the tide suddenly turns. Then it becomes a curse.
“Your reserves may be adequate to service your short-term debt but if there is a massive exit from domestic bond, equity, and deposit markets then your reserves will not be enough,” Akyuz warns. There’s a simple reason for this: a large chunk of emerging markets’ reserves is derived from the initial entry of hot money into their economy.
Last year, investors pulled $6 billion out of emerging market funds managed by Pimco, according to the New York Times. A debt fund run by MFS investment management in Boston lost $1.4 billion, and Trust Company of the West in Los Angeles suffered outflows of $1.8 billion from its $2.6 billion bond offering last year.
Emerging markets’ debt troubles are compounded by an additional factor: an unprecedented bubble in corporate debt, particularly dollar-denominated debt. As The Economist warns, the numbers are startling:
Corporate debt in 12 biggish emerging markets rose from around 60% of GDP in 2008 to more than 100% in 2015, according to the Bank for International Settlements (BIS).
All too often places that experience a rapid run-up in private debt subsequently suffer a sharp slowdown in GDP. To make matters worse, many emerging market governments, most notably Brazil, as well as emerging market companies have seen their credit ratings downgraded in recent months, with many more expected to follow. None of this is good for investors’ nerves. Nor is the fact that it is all happening as a veritable mountain of emerging market debt – all $1.6 trillion of it – is scheduled to come due over the next five years.
The problem is particularly acute among EM oil majors, which continue to suffer the fallout from historically low oil prices and increasingly expensive debt. In early March the new boss of Pemex, Mexico’s state-owned oil giant, warned that the company faced a “liquidity crunch”. Since then it has announced sweeping layoffs. So, too, has Malaysia’s state oil firm, Petronas. Petrobras, Brazil’s teetering and scandal-tainted oil giant, recently secured a $10 billion loan from the China Development Bank to help it pay off maturing bonds. In Nigeria the desperate oil-dependent government has applied for a $3.5 billion loan from the World Bank to make ends meet.
When push comes to shove, oil giants like Pemex and Petrobras depend on government assistance, but that does not come without costs and risks, chief among them the mass transfer of debt from giant corporations onto the sovereign, and ultimately taxpayers, as happened in Europe’s periphery between 2009 and 2011.
The more money companies need from the state, the more strained government finances become. Pemex is already receiving the first increments of a bailout from the Mexican government, as well as emergency loans from government-funded development banks [read… Big-Oil Bailout Begins as Pemex’s Debt Spirals Down]. As is already playing out in Nigeria, the government’s fiscal crisis becomes a liquidity crunch.
“If we face a liquidity crisis – meaning we no longer have enough reserves to meet our imports and stay current on our debt payments and keep the capital account open — what do we do?” Akyuz asks. The choice, he says, is between “business as usual” or a more “unorthodox response”.
“Business as usual” essentially means keeping the capital account open as it gradually runs dry, while using dwindling reserves, IMF emergency loans and IMF-prescribed austerity to keep servicing the expanding debt. It’s the classic approach that has been tried during numerous crises, including Mexico’s Tequila Crisis (1994) and the Asian Financial Crisis (1997).
By contrast, the unorthodox response involves using currency reserves to support the economy and imports, not to sustain capital outflows. It’s time struggling developing and emerging economies began asking themselves whether they are prepared to put their own interests before those of international investors, Akyuz pointedly asserts:
Are we prepared to impose controls over capital outflows? Are we prepared to impose temporary debt standstills? Are we prepared to impose austerity on creditors and investors rather than austerity on the people? These are the issues.
Another key issue is the acute lack of faith of developing and emerging economies in the world’s most influential international institution, the International Monetary Fund.
“The IMF missed one of the most serious crises in the world since the 2nd World War, the subprime crisis,” he says. The Fund’s predictive failings have been no less spectacular with regard to the Global South’s recent performance. “When we were warning, in 2008 and 2009, that the rise of the South was a myth, the IMF was busy promoting the idea that the South was becoming a locomotive for the world economy.”
It wasn’t until late 2013 that the IMF began paying serious attention to the risks posed by emerging market debt, by which time the problem had already become a festering crisis, and one which, according to Akyuz, could soon become the third wave of the Global Financial Crisis. If that were to happen, it would unleash a tsunami of devastation across some of the world’s most vulnerable economies, while no doubt leaving many upscale international investors begging for more bailouts. By Don Quijones, Raging Bull-Shit
The earnings warning and crummy outlook that Monsanto issued was just a precursor. Read… Monsanto Losing its Grip?
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Debts HAVE to be in the local currency. It’s sheer madness to use another nation’s currency. Argentina shows why, although it is somewhat a more extreme bad example. So if one sends dollars to another nation’s reserves it gets translated into that currency, and on exit the spot price will settle how much it gets returned, not the dollar rate differential.
The reason is simple. Only the currency issuing government has control of its currency. No country has control of another nation’s currency. That nation can pay any debt in its own currency. Not so for an outside currency. It has to be a monetary sovereign nation so countries like Greece are excluded. It was seriously unwise for Greece to give up its own currency.
The only reason that a government borrows in a foreign currency, apart from a lower interest rate is because it can’t borrow domestically.
A country like Greece that is determined to live beyond it means, long since exhausted all possibilities of internal financing, particularly since Greeks know better than to lend to their government.
I agree that Greece would be better off staying with its own currency- it would have been impossible to fund its overpaid bloated public sector.
It would never have been able to run up its debt because Greek bonds would have long since lost investment grade rating.
BTW: there seems to be of a fantasy that if you print your own currency you can’t go bankrupt, or run out of money anyway to keep it simple since bankruptcy is a legal term.
Most of the African countries print their own currencies and most are so out of money or credit that you can only phone collect from them; the international phone system doesn’t trust them to forward the other party’s share of the bill.
When Zaire tried to stick another zero on the big bill the merchants wouldn’t take them and a near civil war ensued.
I trust that as stupid as the IMF may have been not to anticipate these problems, it is not responsible for the corruption, incompetent national oil
companies etc.?
It’s our nature of politicians to max out the proverbial credit card that belongs to others, as long as they know they would not feel the pain at the end of the day.
How about Italy and France? Both economies are healthy? Or not?
Why nobody talks about?
The ‘Masala Bonds’ now being issued by the Indian government are denominated in rupees, so foreign currency is converted upon investment and reconverted at market rates on exit, thus placing risk on investor not issuer – hedge against currency fluctuation for Indians. Might stop red hot money flows and encourage more serious investing, no?
India can probably do this- it has a good growth rate and so far not a bunch of overly generous entitlements that it can’t afford. Thus the investor may well accept the currency risk as well as the sovereign risk ( the risk that the borrower may not repay in whatever currency)
However neither Greece, Portugal, Mexico etc. would have been able to borrow in their own currencies because the investor would not accept the risk unless compensated with an appropriate interest rate ( think double digits)
I had some friends teaching in Thailand when the Asian Financial Crisis hit. Their one year contracts were in Thai baht, which then fell by 50% in a few weeks. They could still live, but there was no hope of saving any money to bring home.
That’s why Thailand cannot easily borrow in baht, except domestically of course but the funds needed for large projects exceed domestic savings.
Also people with savings in these places are also reluctant to exchange then for baht denominated promises.
There seems to be a meme here that a bunch of countries with some very smart people in their finance departments for some crazy and unnecessary reason decided to borrow in US$ instead of their own currencies.
PS: of course they shouldn’t have been borrowing to excess at all, but elected politicians promising goodies were responsible for that, as well as the people who voted for goodies.
Italy and France are as safe as any other countries who are in the EU and have the Euro as their currency. Yes just as safe as the the passengers were on the Titanic.
They are being pulled along by the ‘big black engine that could’
so far.
Oh no, no they are not safe, not even nearly as long as Germany won’t give up with it’s current way handling things, especially the trade surplus which sucks all other euro countries dry.
That’s because as long as Germany keeps it’s head the other major euro countries can not get decent growth numbers with their already shrunken and anemic economies.
For Italy i don’t know but in France that means vive la révolution in ways that will still matter although maybe not with guillotine for PTB these days anymore…
Wait and see, especially if Brits have the guts to say LEAVE to EU.
Do the Brits have the guts to leave the EU? One has to remain sanguine about it, I think. My own view is that either we leave now, through choice, or we leave later, through necessity.
It’s fun to think about Germany leaving the euro (or being expelled lol)
and going back to the D-mark.
The euro would drop to who knows- 70 Cents US? Which ought to give the rest of Europe’s manufacturing a break.
All those who blame nasty Germany for not wanting to fund Greek public sector salaries that in some cases exceed Germany’s for comparable jobs would have to blame Italy, Spain etc. Or maybe those countries once freed of German parsimony would be glad to send more euros.
The heat would be off the US dollar which would no longer be the safe haven currency. There would be a clean shirt in the laundry!
The guys in trouble would be German manufacturers-but they are already not cost competitors- one question is what will the US pay to drive Benz- BMW- Porsche etc.
Quite a bit- but VW, that has to compete in the value area might face head winds in addition to the ones it already has.
Sweden imposed temporary border controls to stem a record inflow of refugees as the Nordic nation pleads with the rest of Europe to help deal with the biggest migration wave seen in the region since World War II.