Are emerging markets really worth the risk?
At a time when the US Federal Reserve has well and truly capitulated on its hiking path, some emerging markets are not showing signs of relief.
Against the dollar, Argentina’s peso is close to an all-time low, the Turkish Lira is teetering near a year-to-date low, and the South African rand is creeping back to December levels.
Where would those currencies be in a world where the Fed was still tightening, dare I ask?
A higher interest rate in America is seen as detrimental to emerging markets, as it leads to outflows in capital as bond investors look for higher yields in the US. It also makes it harder for countries to pay off their dollar-denominated debt.
A dovish Fed may have taken the pressure off emerging markets, but investors have now become more attuned to the mantra that not all of these economies are cut from the same cloth.
In fact, the currencies that have suffered this year are not only the countries with high external dollar liabilities, but also happen to be the ones facing the softest growth conditions.
Argentina is in the depths of a recession. It contracted 6.2 per cent in the last quarter of 2019 as President Mauricio Macri grapples with high levels of inflation and pressure from the International Monetary Fund to implement austerity measures.
All of this ahead of an election later in the year.
Turkey is also in the midst of stagnation. The economy contracted three per cent toward the end of 2018, inflation is just shy of 20 per cent, and the lira depreciated 30 per cent in 2018.
Analysts have labelled the local elections this past weekend as a referendum on President Recep Tayyip Erdogan’s policies, but one trader told me that more volatility is likely either way, as locals continue to buy dollars and are worried about the growth outlook.
In a note last week, Robin Brooks, the chief economist at the Institute of International Finance, said that “markets would like to see a shift in the growth model: away from a credit-dependent model towards a more sustainable one”.
According to Brooks, no one should assume that the trouble in Turkey is an isolated event, as investors become increasingly wary of financing countries that are too heavily indebted or dependent on credit.
The world was shaken up by a confluence of factors last year: tightening financial conditions, a slowing China, a global trade shock, and financial market instability.
With optimism about a China-US trade deal, the Fed turning dovish, and positive data out of China over the weekend, one could say that the worst is behind us.
But what if the worst has merely been postponed as indebted countries have not used this time to repair their growth composition? Turkey is a good litmus test.