Oil prices and the dollar are stronger. US Treasury yields are rising in anticipation of fiscal expansion and monetary tightening. Global debt has ballooned during a long spell of strong growth and easy money.
After a week when Argentina’s central bank battled furiously to defend the value of the peso — raising interest rates from 27.25 per cent to 40 per cent in the course of a few days — are these warning signs of further distress to come across emerging markets?
For investors of a nervous disposition, there are echoes here of the conditions that led in 1982 to one of the best-remembered episodes of market turmoil: the Latin American debt crisis. Add to this the risk of a full-blown trade war between the US and China, and the ingredients are there for an emerging markets meltdown.
Yet the prevailing view among economists is that Argentina was an outlier, with factors that mitigate against a wider crisis.
“We don’t see how it’s going to turn into a big macro reversal,” said Gabriel Sterne of Oxford Economics. With interest rates still low by historic standards, the situation was much less threatening than in the 1980s, he said. At that time, when many emerging market central banks were still pegging their currencies to the US dollar, “there was a big, big rise in [US Federal Reserve] rates and nothing could withstand that”.
The backdrop of solid global growth remains supportive. The IMF predicts that growth in emerging and developing economies will accelerate from 4.8 per cent in 2017 to 4.9 per cent this year and 5.1 per cent in 2019 — even if a softening in recent data makes these forecasts look optimistic.
Most of the larger emerging markets are also better able to withstand shocks than in the past. As well as more flexible exchange rates, they have higher foreign currency reserves, smaller current account deficits and a bigger share of sovereign debt issued in local currency.
Mr Sterne noted that emerging markets weathered the biggest capital outflows on record in the last period of turbulence, from 2015 to 2016, with only two large economies — Brazil and Ukraine — sinking into recession.
The heat will be on emerging markets in the short term, however, especially for countries such as Turkey, an energy importer with a large current account deficit, where investors are already wary of rising inflation, high dollar-denominated borrowing by companies, autocratic government and worsening economic management.
Others will look more or less vulnerable depending on which risk comes to the fore. A surge in the oil price would hurt importers such as India, Indonesia and the Philippines — where inflation is closely correlated with energy costs. But it would benefit Russia and Saudi Arabia.
The Institute of International Finance said Ukraine, China and South Africa, alongside Argentina and Turkey, looked most vulnerable to changes in risk appetite, because they had weaker institutions, less adequate reserves and, bar China, relatively high financing needs.
The most acute pressure could be on some of the poorest countries. The IMF warned last month that 40 per cent of sub-Saharan economies were at high risk of debt distress, some because they were struggling to finance foreign currency debts after a depreciation.
William Jackson, at Capital Economics, said countries such as Bahrain and Oman that had run up big budget deficits during the oil price slump could also struggle, as could Lebanon. These pressures will lessen if the dollar goes into reverse, or if oil prices ease.
The big risks that markets may not yet have fully factored in are political, particularly in Latin America, which faces a string of presidential elections this year. Although rising commodity prices are of help, Colombia, which is in the throes of a difficult peace process even as neighbouring Venezuela collapses, has presidential elections on May 27. In Mexico, Manuel López Obrador, a leftist nationalist who considers Fidel Castro a hero, looks set to sweep to the presidency on July 1.
“Markets still seem complacent about the [Mexican] presidential election,” Claudio Irigoyen, analyst at Bank of America, wrote in a recent report.
As for Brazil, its elections in October are so wide open that the two candidates leading the polls are former president Luiz Inácio Lula da Silva, who is in jail on corruption charges, and Jair Bolsonaro, a rightwing congressman regarded as a mix of US president Donald Trump and Philippine strongman Rodrigo Duterte.
A broader concern is the growing threat of a trade war between the US and China, whose effects would ripple through regional supply chains — with South Korea and Taiwan likely to be hardest hit.
“Markets are not yet pricing in a long and ugly US-China confrontation,” said Jon Harrison, economist at TS Lombard, adding: “over the next few months, trade tensions, dollar strength, higher Treasury yields, rising inflation, weaker current accounts and geopolitics will lead to a deeper correction”.