By Phillip Inman
As America’s economy booms, investors are lured back to the US – and away from the countries that were relying on them.
In the past six months, some of the world’s fastest-growing economies have found themselves flat on the floor, gasping for breath and, in one case, seeking help from the global financial rescue centre otherwise known as the International Monetary Fund.
Argentina’s $50bn bailout by the Washington-based lender of last resort is the most extreme event so far, but it sits alongside the dramatic collapse of the Turkish lira, a recession in South Africa and dire economic predictions for the Philippines, Indonesia and Mexico.
Making matters worse, the US is poised to slap tariffs as high as 25% on as much as $200bn worth of Chinese goods. If the US goes ahead, Beijing has already threatened to retaliate, which would only incense President Donald Trump further. This tit-for-tat might only end when tariffs are applied to the entire $500bn of Chinese goods imported by America each year.
In response, the stock markets of many developing nations have slumped in value, leaving investors to ask themselves whether they are witnessing an emerging-markets meltdown akin to the Asian crisis of 1997: a panic that wrecked the finances of several hedge funds and proved to be an hors d’oeuvre before the dotcom crash of 1999 and the global financial crisis of 2008.
Investors have run for safety to such an extent that the MSCI Emerging Markets index, which measures the value of shares in emerging economies, has tumbled by more than 20% since the beginning of the year.
That slump appeared to be over in July, when Turkey and Argentina were seen as being isolated, and more importantly ringfenced, economic trouble spots. But figures last week showing that the US economy is steaming along like a runaway train – underlining the likelihood of more US interest rate rises – have sent the currencies and stock markets of most emerging-market economies tumbling again.
Lukman Otunuga, research analyst at currency dealer FXTM, says that a sense of doom is lingering in the financial markets as fears of contagion from the “brutal emerging-market sell-off” rattle investor confidence.
“More pain seems to be ahead for emerging markets as the combination of global trade tensions, prospects of higher US interest rates and overall market uncertainty haunt investor attraction,” he says.
The closely watched ISM survey of US manufacturing showed the sector was just a few points away from reaching its all-time high, recorded in 1983. That puts factory output at bursting point, with car firms and the aerospace industry working around the clock to satisfy demand at home and abroad.
In the second quarter of the year, the US economy was running at an annualised growth rate of 4.1% – much higher than the UK and eurozone, which are expanding at a sluggish 1.5% by comparison.
Analysts are convinced these figures, coupled with low unemployment, will persuade the US central bank, the Federal Reserve, to keep raising interest rates this year and into 2019. Federal Reserve chair Jerome Powell said as much last month in a speech to his international counterparts at the annual Jackson Hole central bankers’ meeting in Wyoming.
Alarmingly, he praised Alan Greenspan, who ran the Fed in the 1990s and early 2000s, for spending the latter part of his tenure steadily increasing rates to choke off a boom. It was an unfortunate analogy to draw, given that Greenspan is now known for keeping rates too low and allowing first the dotcom bubble and then the bank lending boom, only raising rates when it was too late.
But investors didn’t need Powell’s speech to read the signals. They understand that two potentially disastrous trends for emerging markets are set in motion by higher US interest rates.
First, billions of dollars invested in emerging-market stocks and bonds begin to make their way back to the US, where they can once again earn a decent return in deposit accounts without taking any risks. To prevent some of this money departing their shores, emerging-market economies must put up their own interest rates. That solves one problem only to create another – namely that borrowing in the local currency becomes more expensive for domestic businesses and households.
Secondly, the cost of borrowing in dollars soars, hurting all those emerging-market businesses and governments that have borrowed from US banks in dollars over in the last decade to help fund their expansion.
The US Federal funds rate has moved up from 0.25% in 2014 to 2% today. A rate of 3% in the looks likely by the end of next year.
Turkish businesses are among those that took out cheap loans before 2014 to invest in new factories, meaning they have enormous borrowings in dollars. Now that they must re-finance these debts, they face shockingly high interest rates.
Furthermore, to prevent the Fed’s actions influencing the domestic economy, Turkey’s president, Recep Tayyip Erdoğan, has put his brother-in-law in charge of the finance ministry and is seeking to control the central bank, preventing it from raising rates.
However, Erdoğan’s interventions have only made the situation worse. Inflation has hit almost 18% and is still rising. An effective freeze on interest rates robs the state of a key tool in calming inflation. It also encourages more cash to leave Istanbul’s banks for New York.
But Mark Mobius, the financial trader frequently referred to as “Mr Emerging Markets”, says that while Turkey and Argentina have had severe problems, most developing nations have sought to protect themselves from rising US interest rates. China is also capable of weathering the immediate storm.
“The big devaluations have taken place,” he says. “And the ones we will see from now on will be incremental.”
He says that while no on knows where the bottom of the market will be, he is buying shares in emerging-market companies on the basis that if they fall further, it will not be far.
Brian Belski, chief investment strategist at Canadian trading firm BMO Capital Markets, says those who argue that emerging-market chaos could spread to the rest of the world are wrong. “I don’t think they should be using words like ‘contagion’. The global economy is in good shape and the countries we are talking about have minuscule GDP numbers. They are just too small to hurt the global economy.”
The second tier of affected countries, like South Africa and Indonesia, are also likely to follow Argentina’s lead and win round investors with austerity programmes to bring down borrowings. It is a policy that has the potential to trigger domestic strife, but it will prevent even more of them from joining the exodus.
Countries in the spotlight
The Argentinian central bank raised interest rates to 60% last month in an effort to prop up its plunging currency. This did not placate investors, so the government launched sweeping austerity measures to try to restore confidence. The currency crisis is likely to push the economy into deep recession. It has asked the IMF to accelerate the payment of $50bn in emergency funding to bolster its finances. Finance minister Nicolás Dujovne said the austerity measures – and higher export taxes– would allow Argentina to achieve a balanced budget next year, instead of a 1.3% deficit as previously expected.
South Africa unexpectedly plunged into recession in the second quarter of 2018, recording a 0.7% drop in GDP and triggering a sell-off that took the rand to its lowest level in two years.
President Cyril Ramaphosa, who replaced Jacob Zuma earlier this year in a whirlwind of optimism for the economy which sent financial markets soaring, says the recession is a “transitional issue” from which the economy will recover. Unemployment is at 27.2% and rising, bringing a risk of nationwide protest over the state of the economy.
The country’s unfolding crisis is likely to push it into deep recession as inflation continues to rise. The lira has fallen to the lowest levels on record, pushing up borrowing costs. President Recep Tayyip Erdoğan remains defiant, accusing foreign interests of waging economic war on the country.
In the US, Donald Trump has slapped tariffs on the country’s steel exports in a bitter dispute over the detention of Andrew Brunson, a US pastor accused by Turkey of espionage. Emergency support from the IMF has been mooted, and Turkey is also under pressure to raise interest rates, though Erdoğan may resist this.
High levels of corporate debt have fuelled global fears about the Chinese economy and its ability to reduce reliance on debt and maintain growth. The picture is complicated by Trump’s threat to impose $200bn of tariffs on Chinese exports. Investors are concerned an escalation of the trade war could slow global growth, as China is a key driver of the world economy. The yuan has dropped against the dollar this year, which could alleviate the impact of the tariffs on Chinese exporters, whose goods will become more competitive.
The Indonesian central bank has had to raise interest rates to shore up its currency. The rupiah is at a 20-year low, prompted by rising debt and numbers of investors betting against emerging markets. Indonesia has the highest debt to foreign creditors of any Asian country, at 35% of GDP. As inflation has so far remained under control, the central bank would probably have preferred to cut rates to stimulate its struggling economy, but fears over the currency fall forced it to raise rates instead.
If the outlook deteriorates further, neighbouring countries including South Korea, India and the Philippines could be forced to take similar steps.
Trump’s steel tariffs and his threat to force US businesses to bring back production outsourced south of the border hang like a dark cloud over the Mexican economy, putting the pesounder pressure. A renewal of the North American Free Trade Agreement would benefit Mexico: it has struck a deal with the US, but talks with Canada are ongoing.
The rupee is at an all-time low against the dollar amid concern over the impact of protectionism and higher US interest rates. High inflation has led to protests in Delhi overfuel prices. India is the world’s fastest-growing economy, with growth of 8.2% in the three months to June. But its trade deficitworsened in July to $18bn because of higher fuel imports and rising global oil prices. Government economists are sanguine about the currency, but others fear slower growth ahead.