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?