Understanding the financial turmoil in emerging markets

LONDON – Argentine families are trying to cope with 30% inflation. Companies in Turkey face bankruptcy if they can not pay their debts up. And investors betting on emerging markets will be in the red this year.

The financial turmoil has engulfed many developing countries this year, with investors worried about the impact of rising interest rates and trade disputes on these rapidly growing, but often fragile, economies.

Argentina has seen its currency fall by more than half this year, while the Turkish lira has almost fallen. Falling currencies shook confidence in some stock markets as the Indonesian index fell 4% on Wednesday.

The Iranian rial reached a record high last week and the Venezuelan currency lost almost all its value as the deep economic crisis of the country led to one of the worst cases of hyperinflation.

The concern is that large losses in some developing markets could affect the global financial system, as in the past, especially in the late 1990s, when several Asian countries eventually needed financial relief.

According to Ashmore Investment Management specialists, emerging market volatility is the highest since the global financial crisis of a decade ago, showing how much of the problems in one part of the global economy can spread.

While the nervousness of the market continues, here are some potential causes and consequences.

The root cause: The US Federal Reserve's willingness to raise interest rates regularly is widely seen as the root cause of the crisis that has hit many emerging markets.

In an attempt to reconstruct economic growth after the financial crisis, US rates have remained close to zero for almost a decade. This allowed investors to buy foreign assets with money borrowed cheaply and encouraged banks to lend to emerging market companies in hopes of higher returns.

But while the economy has improved, the Fed reversed the course. He raised his key rate in June to 1.75-2% and plans to raise it further. Rising US rates have prompted banks and bond investors to withdraw money from riskier emerging markets.

This has revealed financial vulnerabilities in some countries. Turkey and Argentina have been identified as the two most vulnerable because of a series of factors.

"Once the stress period starts, you look at where the red flags are," said Evghenia Sleptsova, senior economist at Oxford Economics. "Argentina and Turkey are the two economies where imbalances are the most important."

Dollar strength: The rise in US rates has pushed the dollar up about 3.3% this year compared to a basket of currencies. This figure includes sharp increases over some currencies, such as the Argentine peso.

The rising dollar makes dollar-denominated debt more expensive to serve, a particularly important concern in Turkey and Argentina, where many loans have been taken in foreign currency.

The fall in local currencies may also encourage foreign investors to withdraw emerging market equities and bonds from money. The MSCI Emerging Markets Index is down about 15% from its peak this year. Falling foreign investors are only adding to the currency defeat and pushing central banks to raise their interest rates, which is weighing on growth.

Turkish, Indonesian and Indian central banks have increased their benchmark interest rates, partly to boost confidence in their currencies by increasing the returns of global investors. Argentina recently raised its key rate by 15 points to 60%, in a desperate effort to end the peso's downfall after President Mauricio Macri said he was asking the International Monetary Fund to mobilize financial support from 50 billion dollars.

The future of these economies – and if their turbulence spreads to other markets – will largely depend on the possibility that their rate of increase and reforms will stabilize their currencies.

Neil Mellor, currency strategist at BNY Mellon, says the situation does not seem as bad as it was in Asia in 1997, when similar financial problems led several countries to resort to the IMF bailout.

"But we have a number of seemingly intractable problems with potential for mutual reinforcement of investor confidence," said Mellor.

International trade: The growing trade tensions triggered by the United States have added uncertainty to the global economy, making the market turmoil particularly uncomfortable for emerging markets.

Turkey is a typical example. One of the reasons for the fall of its currency this summer was President Trump's decision to double US tariffs on Turkish steel and aluminum because of Turkey's decision to imprison a Protestant American pastor.

Fears of a trade war between the United States and China also contribute to the sluggishness of emerging markets. Economic indicators already indicate a slower than expected slowdown in the Chinese economy, the second largest in the world, especially among small businesses. A trade war with the United States will only aggravate the situation. And this has increased the pressure on Chinese equities as well as on the yuan, the Chinese currency.

Perspective: Until now, market watchers do not expect the crisis to turn into a global financial crisis.

But some countries are more vulnerable than others. Argentina and Turkey stand out as the emerging economies with the most problems to solve, namely the improvement of the public budget, the service of foreign currency debt and the repression of inflation.

And unique events can still provoke market turbulence in a given country – whether it's the upcoming elections in Brazil, fears of sanctions in Russia, South African land reform or even d & # 39; 39, a tweet from Trump.

Many experts believe that most emerging economies are fundamentally stronger than they were ten years ago, when global financial crises shocked their markets. Countries like Malaysia, Thailand and South Korea have stronger financial cushions in the form of current account surpluses.

"Turning points are always hard to pinpoint," warns Jan Dehn, research manager at Ashmore. But "the balance of risks," he added, "is slowly starting to favor emerging markets."

Pan Pylas is associate editor.