Nomura Lists Out ‘Troubled 10 EMs’. Is India In There?

Consensus suggests that emerging markets are less vulnerable now than they were in 2013, when the last taper tantrum hit markets globally. Monikered as the ‘Fragile Five’, countries with high inflation, twin deficits were worst-hit. India was among them.

Now as markets watch for a wind down of the U.S. Federal Reserve’s asset purchases, Nomura, in a contrarian call, said not all EMs would be protected from a sharp volatility.

According to them, at least 10 EMs have fresh vulnerabilities which could expose them as central banks start to slow the accommodative policies put in place to combat the economic crisis brought on by the Covid-19 pandemic.

“We disagree with those who believe that EM is in a more resilient position now than it was on the eve of the 2013 taper tantrum. EM has developed new sources of vulnerability, with a combination of chronically weak growth, rising inflation and a marked deterioration in fiscal finances, and yet real policy rates remain deeply negative in many EM countries?” says the report dated Aug. 27.

The New Vulnerabilities

According to Nomura, the prospect of the Fed normalising monetary policy amid China’s slowing economy is a “dreadful combination” for EM.

This is made worse by the three EM vulnerabilities that it has found lurking in the shadows:

1. A growing EM bank-sovereign debt nexus that raises the risk of a so-called bank-sovereign doom feedback loop, the type of loop that was at the heart of the 2009-10 European debt crisis. In addition to several low-income, frontier economies, Brazil and India appear most at risk of a doom loop.

The bank-sovereign doom loop refers to a vicious cycle where a sovereign’s expanded debt is held largely by banks, thereby exposing them to volatility linked to sovereign rating downgrades.

2. According to Nomura, just because EMs have attracted smaller cumulative portfolio inflows since Covid-19, does not mean that they are less susceptible to large capital flight.

Gauged by portfolio liabilities, as opposed to cumulative portfolio inflows, many EMs are likely more susceptible now than on the eve of the 2013 taper tantrum, once asset revaluation effects are taken into account, it said.

3. From a saving-investment framework, EMs’ extraordinarily large fiscal deficits will likely leak into sizable current account deficits.

The countries that appear most at risk of running excessively large current account deficits, alongside still-large fiscal deficits, are Colombia, Peru, Romania, Turkey, and South Africa.

India Escaped The List But…

While India was not included in the list of 10 vulnerable countries, Nomura flagged certain concerns.

Apart from the worry over a sovereign debt-bank ‘doom loop’, Nomura flagged a possible central bank “overreach”.

“EM central banks have recently started raising rates, but many are only matching the rise in inflation, resulting in still deeply negative real rates,” said Nomura.

Explaining this, the report said policies pursued by some EM central banks have led to inadequate interest rate return (that is, risk premium) to foreign investors to compensate for weaker economic fundamentals.

“…several countries appear exposed, notably Brazil, Colombia, Hungary, Peru, Romania, Turkey, South Africa, India and the Philippines,” Nomura said.

What may have worked in India’s favour is its relatively modest current account deficit for now and its large forex reserves. India’s general government fiscal deficit of nearly 10% is, however, elevated and inflation is above the central bank’s target.