Emerging Markets Brace for Pain as Fed Hikes Meet Trade War
(Bloomberg) -- Policy makers across emerging-markets, already rattled by an exodus of capital and tumbling currencies, are bracing for a protracted struggle in the face of rising U.S. interest rates and a deepening trade war between the world’s two biggest economies.
Finance officials from Colombia and Mexico meeting in Bali for the International Monetary Fund and World Bank’s annual meetings pointed to rough times ahead, and even the risk of a full-blown crisis for the unprepared. Indonesia’s central bank vowed to stay "ahead of the curve" on monetary policy as the U.S. Federal Reserve continues on its tightening path.
The prospect of a deepening rout in emerging markets was underscored this week with the IMF cutting its outlook for world growth for the first time since 2016. Meantime, Pakistan requested yet another bailout from the fund, following Argentina in requesting assistance.
“Headwinds from higher oil prices, Fed interest rate increases and a stronger dollar, and the possibility of an escalation of trade tensions, don’t seem to be issues that will be resolved in three to five months,” Changyong Rhee, director of the Asia and Pacific department at the IMF, said in an interview. "Policy makers need to save ammunition,” he said, citing reserves, fiscal space and monetary space.
The IMFC communique issued Saturday noted that while the global economic expansion remains strong, risks are "increasingly skewed to the downside amid heightened trade tensions and ongoing geopolitical concerns, with tighter financial conditions particularly affecting many emerging market and developing countries."
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The scale of the fallout from rising U.S. interest rates and a stronger dollar has been varied, as has the scope of the responses across emerging markets. But it’s not just policy makers in the developing world who are grumbling: President Donald Trump launched a fresh attack on the U.S. central bank this week, decrying the Fed’s policy path as "going loco."
Mexico’s Finance Minister Jose Antonio Gonzalez Anaya urged counterparts to heed the lessons of the past. Whereas the three main challenges for Mexico’s economy a year ago were elections, renegotiation of the Nafta free-trade agreement, and monetary policy normalization, only the latter now remains.
FX Intervention
“As emerging market economies, we have to prepare, because in the past when you’re unprepared, you have the debt crises,” Gonzalez Anaya said in an interview. “There was Fed monetary tightening in the early 1980s and we had the debt crisis. There was Fed monetary tightening in the 1990s, and you had the Mexican tequila crisis.”
Emerging economies are keeping an eye on rising interest rates as they consider plans to sell international debt to finance infrastructure and other spending priorities, Kenyan Treasury Secretary Henry Rotich told reporters in Bali on Saturday. “It is critical that we monitor, because it has ramifications especially on our exposure of debt we already have with international investors,” he said.
Although capital outflows from Colombia have been minimal in recent months, the central bank has begun buying reserves. “We want to increase the buffer because we’re going to have rough times in the world in the next two years, I’m afraid,’’ Colombia’s central bank governor Juan Jose Echavarria said in an interview with Bloomberg TV.
Paraguay’s central bank is in the process of implementing a framework to supervise risks in individual banks and insurance companies, with support from the IMF, akin to "a doctor that prescribes medicine for a sickness before it comes,” said Governor Jose Cantero. "It’s not common for the malignant stars to align like they are now. It only happens once every 15 to 20 years.”
No Magic Bullet
Hikes to U.S. interest rates, trade protectionism, higher oil prices and China’s slowing growth are among the many headwinds facing Asia. Wobbles in stock markets have added to jitters. Higher U.S. borrowing costs have been draining capital from Asia and putting governments and central banks under pressure; in turn many have tightened their own monetary policies, cut spending and strengthened lines of defense.
Even before most major nations in Latin America start raising borrowing costs, the IMF forecasts the region in 2018 will have the weakest growth of any emerging-market group. While rising oil prices since last year have been a boon to producers, agricultural commodities like soy and corn have fallen markedly, weighing on tax receipts. There’s concern oil may falter, too, if global growth slows.
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Argentina may provide an idea of worst-case reversals in store: higher U.S. rates combined with the nation’s fiscal weakness prompted investors to dump its assets and, with the peso in free-fall, the central bank raised the benchmark rate to the highest in the world. The IMF now forecasts back-to-back recessions in 2018 and 2019.
There’s no “magic bullet” for how emerging economies can respond to the volatility that’s shaking them, Hyun Song Shin, economic adviser and head of research at the Monetary and Economic Department of the Bank for International Settlements, told Bloomberg Television.
Instead, governments need to do the basics right like build buffers and bolster underlying fundamentals, he said. "The lesson is you shouldn’t drink too much from the fountain of global liquidity.”
With the trade war between the U.S. and China showing little signs of abating, the IMF’s Rhee has warned the issues facing emerging markets may persist for another 18 months or more. Indonesia’s investment chief Tom Lembong, a former trade minister, has urged vigilance for all emerging markets.
"There’s really only one discussion that’s happening here, in earnest," said Robin Brooks, the Institute of International Finance’s chief economist. "And that is basically the intensity of the trade dispute between the U.S. and China and how bad that will get - how prolonged and how pernicious."
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