Daily Times

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 Erdogan, 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, Erdogan’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.

What is an emerging market?

Countries whose national economies are progressing towards becoming advanced are known by City investors as emerging markets. The largest of these are collectively called the Brics – Brazil, Russia, India and China. These countries tend to have lower per-capita income than developed markets. They are also typically moving away from basic activities such as farming and mining towards manufacturing and services.

The phrase can also be shorthand for nations that are adopting free-market economic practices as they become more aligned with nations such as the US, Britain and Japan. Emerging markets are prone to rapid change and are often more exposed to factors outside their control.

Published in Daily Times, September 10^th 2018.