Rajrishi Singhal:
There is palpable fear hanging over the global markets which are interconnected through pathways that allow transmission of goods, services, capital and confidence. These neural networks are now in a fragile state and are furiously signalling the likelihood of another crisis. A limited suite of solutions available, unlike 2008, has intensified apprehensions.
An inchoate nervousness, that has undergirded market behaviour over past six months, spilled out into the open after the International Monetary Fund’s (IMF) October 2018 edition of the Global Financial Stability Report (GFSR) explicitly mentioned that risks had intensified and emerging markets could bear the brunt of the next crisis. The report stated: “As central banks proceed with the withdrawal of monetary accommodation, financial conditions will eventually tighten. Such a tightening could reveal financial vulnerabilities that have built up over the years of accommodative policies and may also expose fragilities in the financial system that have emerged since the global financial crisis.” In addition to monetary policy normalisation undertaken by central banks of rich economies which has resulted in capital outflows and economic instability in emerging economies, the ongoing trade wars are also likely to impact asset valuations and economic fundamentals.
The IMF report perhaps fed off the apprehensions expressed earlier by Mario Draghi, president of the European Central Bank. Addressing the European Systemic Risk Board’s annual conference in end September, Draghi focused attention on the mounting risks in the shadow banking industry in the form of swelling debt. “Policymakers need a comprehensive macro-prudential toolkit to act in case existing risks migrate outside the banking sector or new risks emerge.”
Speaking at the International Monetary and Financial Committee meeting in Bali on 13 October, India’s economic affairs secretary Subhash Chandra Garg said: “Growth in EMDEs (emerging markets and developing economies) is expected to remain robust but faces substantial downside risks from tightening of global financial conditions, intensification of market pressures, rising oil prices and reversals in capital flows.”
In such a scenario, emerging economies—in particular, countries with moderate-to-high external debt, a widening current account deficit, a narrowing policy space due to either political exigencies or limited resources—are at the greatest risk. The fear that should another crisis break out, resulting in contagion, policymakers and central banks have no new tools left to contain after-effects has added to the unease.
This overlooks another concern: the 2008 crisis had fostered a global coordinated policy offensive against the economic slowdown, with governments and central banks synchronising their regulatory frameworks and policies. G-20, till then an exclusive club of central bankers and treasury officials, was broadened to include the leadership and provide political agency to push through sweeping policy changes. This also included shaping a global regulatory overhaul. All of this helped to limit the effects of the slowdown. However, if another crisis erupts today, it is moot whether a similar global coordinated effort can be mounted. In addition, the US had taken the lead in 2008 to use G-20 to orchestrate a global revival; while taper tantrum provided a preview of the US’s intentions, its waning interest in multilateralism is already evident. Garg raised this in Bali: “…if major advanced countries were to think of the entire world, and not merely their national constituencies, and work in a spirit of global cooperation, we would possibly be able to revert to expansion of global economy once again and contribute to development of all.”
According to a 10 October blog on the IMF website, the global markets are able to adjust to rising dollar interest rates, and absorb rising asset prices, because of a robust risk appetite. But the same rising rates have put pressure on some emerging economies with large credit needs, fundamentally weak economies and policy frameworks. The menu of risks is rather long and keeps expanding: escalating trade wars, confusion over Brexit, fiscal concerns compounding the debt pile-up in parts of the euro area, and, central banks in some advanced countries normalising their monetary policies at a rapid pace making global adjustments messy. While GFSR does say that most emerging economies might be able to withstand on-going market turbulence, there is an outside chance that they might succumb, leading to a full-blown crisis.
While it is true that most emerging economies are resilient, some outliers—such as, Venezuela, Turkey, Argentina—are already on the brink of a full-blown economic crisis. Their crisis, unfortunately, has thrown up another conundrum: should all emerging economies be lumped together in one vast category, or is there room for greater differentiation? McKinsey Global Institute’s September report (Outperformers: High Growth Emerging Economies and the Companies That Propel Them) highlights divergence within the lumpy cohort known as emerging economies, with some of the emerging economies registering high growth consistently over long periods due to robust domestic policy frameworks.
This distinction seems to be missing from the global narrative about emerging economies, whether among portfolio investors or even rating agencies.