Written by Ryan McGuine //
The global economy has faced a series of dramatic shocks related to the COVID-19 outbreak. While high-income countries have thrown money at their health systems and economies to dampen the hardship, many other countries lack the resources to do so. Emerging markets — a loose term that includes countries like Argentina, Brazil, Egypt, Indonesia, Malaysia, Mexico, South Africa, Taiwan, and Turkey — have been hit especially hard.
When comparing groups of countries, this author usually prefers measures of income. That is partly because it tells something real about well-being there — well-being is fundamentally about solving problems, and income growth over time creates wealth, which makes solving problems easier. It is also partly because other descriptions are not very useful. Designations of first-, second-, and third-world identify a country’s relationship to the Cold War great powers, and the developed-developing distinction implies superiority. One term that gets used frequently in financial circles is “emerging markets.” There is no formal definition for what constitutes an emerging market, but it suggests an economic immaturity, a tendency for booms and busts, and a volatile reputation by creditors. Eric Lonergan defines the term as countries where inflation rises noticeably when money is created (inflation has remained persistently low for decades in Western countries, despite enormous money printing operations).
First and foremost among the challenges currently facing emerging markets is a health crisis. Most emerging markets fall squarely into the low- or middle-income categories, suggesting that citizens have fewer resources than elsewhere to afford healthcare. Many also have population dynamics which amplify the risks posed by COVID-19 like high internal density, and intergenerational cohabitation. Finally, a number of emerging markets have significant preexisting disease burdens, which strains health systems in even the best of times, and may present an additional COVID-19 risk factor. For example, 7.7m South Africans live with HIV, and there are increasing instances of noncommunicable “lifestyle” diseases in emerging markets across the board.
Another challenge for many emerging markets is a dependence on commodity exports for large portions of GDP. This is a problem on multiple counts. First, low diversification exposes countries to risk associated with fluctuations in commodity prices, making long-term planning difficult. Second, demand for commodities is closely related to economic growth, so , demand crashes during slowdowns. Third, commodities are particularly bad stepping stones toward more advanced exports, since the skills involved in producing them do not transfer well into producing other things. Since widespread lockdowns began, demand for commodities has fallen sharply. This was most famously exhibited by negative oil prices in March, but demand for copper, zinc, and rubber have all fallen sharply year-to-date. The longer that commodity prices remain low, the harder commodity-dependent countries will find providing adequate safety nets for citizens.
Complicating matters further for commodity-exporting emerging markets is that a huge share of those commodities go to one place. China has been the leading importer of commodities from emerging markets for decades, so its economic health has an outsize impact on the health of emerging market economies as a whole. Even before the COVID-19 outbreak, China was experiencing economic trouble, causing problems for emerging markets that depend on its imports — Chinese government debt has skyrocketed, and its trade war with the USA has reduced trade proceeds. Then the lockdown caused commodity demand to plunge, and even though China’s economic engine seems to be ramping back up, it is unlikely that growth will continue to be as high as it has been in the past. As countries become wealthier, their economies tend to move away from industry toward services, and the remaining industry depends more on innovation and technological progress than on factor accumulation.
The hit to commodities, as well as other sectors important to emerging market economies like tourism and foreign remittances, has reduced individual incomes and put pressure on governments to respond. Prior to the COVID-19 pandemic, total debt in 30 emerging markets stood at $71tn. That debt curbs governments’ ability to respond, and governments are now borrowing even more on top of that. Governments and companies borrow money by issuing bonds, which pay investors a regular interest rate, and the premium at expiration. However, raising debt is more expensive for for emerging markets than for wealthy countries. Whereas investors are happy to loan money to governments in rich countries for safety from uncertainty, emerging market governments must pay more for a bond with similar terms in order to convince investors to take on the additional risk. On top of that, investors often lend in relatively stable currencies like dollars or euros to protect against falling exchange rates, which make it even more difficult for emerging markets to repay debt when dollars are strengthening like they are currently.
Finally, many emerging markets are home to major state-owned or quasi-state-owned companies. Classic examples of state-owned companies include Codelco, Eskom, Gazprom, Petrobras, Pemex, and Sinopec. Companies that are owned by the state are typically less efficient and less productive than private competitors, dragging down growth and generating fiscal losses or liabilities for the state. They have a tendency to become such a large portion of GDP and employment that it becomes politically impossible to let them fail. Additionally, they often lack sufficient government oversight and regulation, fostering corruption from revenue skimming by government officials, to awarding high-paying positions to friends and family over more qualified applicants. If state-owned enterprises fail to pay the interest on their dollar debts, countries’ sovereign credit ratings could quickly deteriorate, as governments with already-weak finances continually bail out giant, failing companies.
International institutions have a major role to play in easing the burden on emerging markets. The US Federal Reserve created “swap lines” so that eligible foreign central banks can get them quickly, but not all emerging markets have access to the Fed’s swap lines. That is where the International Monetary Fund (IMF) comes in. While the IMF cannot print dollars, it can create new special drawing rights (SDRs), which are credited to member countries and can be converted into dollar or euros later, getting reserve currencies into foreign countries to keep markets from collapsing. Finally, the IMF should work to convince creditors that the poorest countries are insolvent and need debt relief. Both China and the G20 are offering temporary “debt standstills” to ease the burden on debtor countries, but private firms are less likely to offer relief, and emerging markets borrowing dollars from the IMF to pay down private debt helps little. Interested readers can learn more about the tools available to the IMF here.
There are some actions available to emerging markets on their own. Most have found it necessary to run large fiscal deficits in order to keep economies afloat, and some have been drawing on their reserves of foreign currencies to fund a portion of those deficits. Countries keep piles of dollars on hand in the form of US Treasury Securities, particularly if a lot of debt is funded in those currencies, in order to provide liquidity and stave off home currency devaluations. Emerging markets can also use their central bank to buy government bonds, something that has become known as “quantitative easing.” Quantitative easing guarantees that debt will be funded, but often makes foreign investors hesitant to buy that debt. Finally, countries can institute “capital controls” — efforts to limit the flow of money into, or out of, a country. Capital controls can be used to spur the domestic economy by maintaining low interest rates, while preventing major capital outflows (typically, investors would move money elsewhere in response to lower rates), but may deter future investment in the country.
Countries with healthy central bank balance sheets — those with more capital inflows relative to debt — will more comfortably weather the storm. Healthy balance sheets are made easier by trade surpluses, which depend on reducing consumption enough to keep debt in check, while increasing output enough to boost growth. Even before COVID-19, the world was changing. Emerging markets faced the headwinds of premature deindustrialization, declining oil demand growth, and slowing economic growth in China. A post-virus world will see some of those trends accelerated and others diminished, and emerging markets will need to find their niche. They could face protracted slow economic growth on top of the immediate threats to medical and financial systems, but that depends in large part on whether richer countries can work together to preserve the key financial infrastructure of the global economy.