The Coronavirus Is the Biggest Emerging Markets Crisis Ever
The pandemic is starting to topple one of the pillars of the globalization era.
We used to think that the 2007-2008 financial crisis set the standard for a savage global shock. But that crisis took more than 12 months to spread from the overbuilt suburbs of California and southern Spain to the financial centers of the world. The coronavirus pandemic has taken just three months to engulf first China and now Europe and North America. As it has swept west it has triggered an economic crisis whose violence is set to exceed anything we have previously witnessed.
The global shock has an uneven chronology. In the West it was the virus that triggered the financial crisis. In the large emerging markets of the world economy—the likes of Brazil, Argentina, sub-Saharan Africa, India, Thailand, and Malaysia—the virus has yet to arrive at full strength. For them, the financial shock wave is running ahead of the disease. Back to back, the two crises threaten to create an overwhelming maelstrom for emerging markets whose impact on the world economy will be far greater than any rogue U.S. president or trade war.
With their populations at risk, their public finances stretched, and financial markets in turmoil, many emerging market states and developing countries face a huge challenge. Will they have the resources to ride out the challenge? And if not, where will they look for outside assistance in an increasingly divided and multipolar world in which the United States, the European Union, and China have all been through an unprecedented shutdown?
At the head of the list of vulnerable countries is South Africa. The virus count in South Africa is heading rapidly towards a tipping point. Its health system is stretched at the best of times with a population of 7.7 million living with HIV. A lockdown has been declared. The military are being called out. Meanwhile, the rand is collapsing and South Africa’s sovereign debt has been cut by the ratings agencies to junk status. In Brazil, another of the superstars of the globalization era, President Jair Bolsonaro’s inner circle are infected. The currency was reeling even before Bolsonaro decided to discard any strategic approach to the virus. Chile, Thailand, Turkey have all been knocked back. Argentina’s much-needed debt restructuring has been blown off course. India’s stock market is plunging, its exchange rate has slumped and its banks are under pressure. Meanwhile, its booming tech industry and call centers are paralyzed. (If your insurance claim in the United States is held up, don’t be surprised. The back-office workers in Bengaluru who normally process your paperwork don’t have the laptops that would enable them to continue working from home during India’s massive lockdown.)
The shock has delivered a blow not just to stock markets and government bonds. It has hit commodities too. One of the main triggers for the big sell-off came on March 6, when oil talks between Saudi Arabia and Russia broke down. Since then the relentless dumping by the main producers has driven prices down. The high-cost upstarts in the United States’ shale fields are their intended victim. But spare a thought for the other oil exporters. Think of desperately poor Nigeria. Think of fragile Algeria, where oil and gas account for 85 percent of export revenue.
To understand the factors at play in this giant unwinding of investment in emerging markets, consider a business proposition that was iconic of 21st-century globalization: A big-name corporation in the emerging world would offer $500 million in corporate bonds offering a yield slightly above those available in the crowded U.S. market. The size of the issue meant it was included in a influential international index of bonds such as J.P. Morgan’s Corporate Emerging Market Bond Index, which since 2007 has been used by institutional investors in the West to diversify their portfolios. Fund managers would happily take the higher yield on offer from Asian and Latin American corporations whose balance sheets were often more conservatively managed than their daredevil Western counterparts. The emerging market borrower benefited from the margin between U.S. funding costs and the rates of return to be earned in fast-growing economies in Asia or Latin America. At the same time, the currencies in which the emerging-market borrower operated would likely appreciate against the dollar, eroding the cost of the loan.
To finance the deal you would never need to set foot in the United States itself. Huge volumes of dollar-denominated credit circulate outside the United States. Deals such as this are done in places such as Dubai, Singapore, and Hong Kong, key nodes in the global exchange of dollar claims and liabilities. The flag carriers of this globalized world were the likes of Emirates and Cathay, huge international airlines with no domestic market to call their own.
Between 2007 and 2019 the value of internationally traded emerging market corporate debt almost quintupled from $500 billion to $2.3 trillion. And, over a similar period, foreign investors bought up one-quarter of the local currency sovereign bonds issued by emerging-market governments, helping to pay among other things for impressive new infrastructure. Observers of the world economy have been warning for some time that this global debt mountain harbors risks. This is particularly true for so-called frontier borrowers, high-risk low-income countries, whose commercial hard-currency debt tripled over the five years to 2019 to more than $200 billion. At the end of 2019, almost half of the lowest-income countries in the world were already in debt distress.
Now the entire logic of emerging-market investing has gone into reverse. As investors everywhere run for safety, the dollar has surged, making dollar debts more expensive. Commodity prices have tanked. With China, Europe, and the United States shut down, exporters of manufactured goods and commodities have no one to sell to. Hardly surprising that the stock markets from Jakarta to Sao Paulo are in free fall. Emirates, the iconic airline of globalization, has shut down. In the past week, gigantic fiscal and monetary efforts have breathed a flicker of life into stock markets. The sell-off has been too massive for investors not to hunt for bargains. A huge injection of dollar liquidity has pushed the dollar off its highs. But the actual recession in the world’s developed economies has only just begun, and the pandemic has not even arrived in full force in the emerging markets yet.
The pandemic is not the first shock that emerging markets have recently faced. In recent decades, the gigantic flow of investment and trade that has interconnected the world economy as never before has been subject to repeated interruption.
There was the dangerous miniature crisis in China in 2015, when the stock market crashed, the currency slid, and $1 trillion fled the country. A year earlier, oil prices and other commodity prices sagged, sending a shock wave through commodity producers. For many emerging markets, the general slowdown began in 2013 with the so-called taper tantrum, when rumors of a tightening in U.S. Federal Reserve policy had money sloshing back to the United States in search of higher interest rates. Ever since, many emerging market currencies have been on the skids.
The prelude to the taper tantrum was the huge wave of dollar liquidity unleashed on the world economy by the Fed during the tenure of Chair Ben Bernanke. That began with the financial crisis of 2008. Emerging markets, with the notable exception of South Korea, were generally spared the banking crises of that year. The shock for them came in the form of what was up to that point the largest and most sudden collapse in global trade. 2020 will easily outdo it. What rescued emerging markets in 2008 was among other things the gigantic stimulus delivered by Beijing. China launched a credit expansion of wartime proportions, confirming the role that it had increasingly played since the early 2000s as an engine of global growth. China also towed the world economy out of an earlier phase of turmoil that spanned the period between the Asian financial crisis of 1997, Russia’s implosion in 1998, and Argentina’s meltdown in 2001. The crisis in Argentina was particularly severe, resulting in the closure of the entire national banking system, mass rioting, and the evacuation of the humiliated president by helicopter.
Since the 1990s, in short, as much as the emerging markets have benefited from globalization, they have also had to deal with intense volatility. The crises of 1998 and 2001 scarred Russia and Argentina deeply. What we have witnessed in recent months, however, is unprecedented, because it is a comprehensive and almost indiscriminate sell-off on a gigantic scale.
There is a playbook for an external shock of this kind. It isn’t what we used to call the Washington Consensus, the pristine free-market version of 1990s globalization. That approach was buried for good in the wake of 2008. Measures that might once have been considered scandalous, such as capital controls to limit the inflow and outflow of funds, have since been approved not only by desperate national governments, but by the International Monetary Fund (IMF).
In the summer of 2019 no lesser authority than the Bank for International Settlements (BIS), the international club of central bankers, issued a frank summary of how highly globalized emerging markets have learned to deal with financial risks. This advice had three components. First, national governments should use large foreign reserves to supply dollars to their financial systems and slow an excessive devaluation of their currencies. The BIS then advises preemptive regulatory interventions in the balance sheets of corporations—banks, financial funds, and industrial corporations such as oil companies—that are large enough by themselves to upset the national economy. Finally, as a way of stanching an excessive capital movement, the BIS, like the IMF, admits that capital controls may be necessary. For the BIS and IMF to be endorsing capital controls is, as the Economist remarked, a bit like the Vatican giving its blessing to birth control; removing capital controls was the totemic policy of globalization from the 1970s to the 1990s. But the evidence of recent decades is undeniable. The risks of unlimited financial integration are simply too great, especially in an era in which the Fed, the European Central Bank, and the Bank of Japan are engaging in massively expansive monetary policy.
Though neither the BIS or the IMF say so in so many words, these are in fact precisely the kinds of tools that Beijing has used to manage the rise of the Chinese economy since the 1990s. This is the “Beijing Consensus” that dare not speak its name. The Chinese have set a high standard, and the current crisis puts the model to a stern test.
Many emerging markets have followed the Chinese example in accumulating large foreign currency reserves, although South Africa and Turkey in particular are thinly armed in light of their outstanding debt obligations. As for the recommendation to police risks in corporate balance sheets—so-called macroprudential management—that is always a tough proposition in political terms. Banks are influential and politically well connected. Huge state-owned corporations such as Eskom in South Africa, Petrobras in Brazil, and Pemex in Mexico generate risks that are hard to manage. Finally, resorting to capital controls when a country is under pressure is a risky business, because it may spook the market and further escalate the movement of capital that it is trying to calm. The emerging markets’ situation is made even harder to manage by the fact that financial markets in London and Wall Street are gyrating and the major economies of the world are either in, or just barely escaped, free fall. In a world riding out a massive, simultaneous shock, what is the point of strength on which emerging markets should anchor themselves?
Given the crises in the West, one might assume the West’s economic policymakers were exclusively focused on problems at home. But the interest of the West and the United States in particular in globalization is huge. In recent years, emerging markets have contributed ever more to global economic growth. In 2017 the firms in the S&P 500 generated 44 percent of their sales outside the United States. In the financial centers of London and Wall Street, the risk of financial contagion—a viral metaphor that is suddenly very apt—is real. If the efforts by major economies to contain the pandemic are hampered by a financial crisis, that would both protract the humanitarian catastrophe and slow the process of restoring the global economy.
What can the West do? Declaring a trade peace would help, as would getting the economies of Europe and the United States back on their feet. But those are medium-term projects. The urgent requirement, given the kind of financial run we have seen since the start of 2020, is to ensure that emerging markets can meet their needs for dollar funding and defend attacks on their exchange rates—especially with the U.S. dollar, in which their corporations have borrowed billions—without exhausting their financial reserves.
During the previous financial crisis, the two main means for channeling dollar liquidity to emerging markets were the Fed and the IMF. In 2009, the Fed offered Mexico, Brazil, South Korea, and other countries liquidity swap lines under which the central banks credited each other with rations of each other’s currencies. Dollars could thus be passed on to the financial system of the recipients. In recent weeks those swap lines have been restored, and Brazil, Mexico and South Korea are once again the three major emerging markets selected for inclusion. The action taken so far has stanched the spectacular rise of the dollar. But Mexico continues to be under extreme stress. In its case the only option may be more direct assistance from the United States, to which the Mexican economy is umbilically attached.
Brazil, Mexico, and South Korea were included because of their size, the fact that their policymakers enjoy the confidence of their counterparts in the United States, and because of the potential for blowback to the U.S. economy. Among other members of the G-20, it is surprising, given its size and the sophistication of its policymaking, that Indonesia was not included this time around. We do not know what debates have gone on inside the Fed, but it would seem likely that India, Turkey, South Africa, and Thailand were ruled out by a combination of the fragility of their finances, doubts about the autonomy of their central banks, their limited interconnection with the United States, and their ability to deploy other tools such as exchange controls to limit outflows.
Other than direct support by the Fed, the IMF remains the last resort.
After the controversy stirred up by its interventions in the Asian financial crises of the late 1990s, the IMF underwent a profound crisis of legitimacy. Its intrusions into the sovereignty of states such as Indonesia were deeply resented. By 2007, the fund’s client list of borrowers had shrunk to a handful. Its budget was cut and its staff was shrinking. There was even talk of abolishing the IMF altogether. The crisis of 2008 saved the fund. For those outside the charmed circle of dollar liquidity provided by the Fed, the IMF rolled out a range of programs to provide further funding. To enable it to do so was one of the first major tasks of the G-20, which agreed at its second-ever leaders’ summit in London in the spring of 2009 to raise the IMF’s funding to $750 billion. Today, the IMF, under new leadership, is readying itself to offer those funds if necessary. Who will be its first client? One might have expected a queue to form—but there will be no urgency among potential borrowers, most of whom will likely consider a trip to the IMF a humiliating ordeal. The first in line will likely be the poorest and most desperate “frontier markets.” Sub-Saharan Africa may well face a new debt crisis like that which culminated in the debt-relief campaign of the early 2000s. Others may wait for longer than is good for them to apply for help. Hence the urgent calls from development economists for the IMF to issue $500 billion in Special Drawing Rights (SDRs). The SDR issued by the IMF is the closest thing we have to a universally acceptable global currency not tied to a national central bank. Giving credits of SDRs to those under greatest stress would provide immediate relief. And if the rich countries that do not need the SDRs lent their quotas back to the fund, they would significantly increase its overall firepower.
Beyond the need to cushion acute financial stress, what emerging markets really need is a restoration of business as usual in the world economy. For that, the Europeans and Americans must rescue themselves. But there is now a third key party in the global economy: China. Having successfully achieved a grip on the virus, China appears to be exiting the economic crisis sooner than either Europe or the United States. It has rapidly rewritten the script of its own botched efforts to deny the virus in January. It is rolling out medical aid to other countries. But can it do more? What can it do in economic and financial terms?
What is striking so far is how quiet the economic news about China has been. Though the crisis started there, the Chinese financial system has been carefully shielded by the People’s Bank of China. The Chinese currency has been relatively stable. This is a huge blessing for emerging markets. The only thing that would be worse for them than the dollar surging would be the dollar surging and the renminbi falling at the same time. They depend for their competitiveness on the balance of those two currencies. Both China and the United States are major markets. Commodities are priced in dollars, and so, too, is funding.
But if the Chinese financial system has so far been relatively immune to the panic, what has been missing is the kind of spectacular economic boost arranged by Beijing in 2008. The battle against the virus has been conducted in the manner of a Mao-era “people’s war.” Financial stimulus, including special lending by policy banks amounted to no more than $430 billion, less than either the United States or Germany has mobilized.
Of course, the regime may be biding its time, regaining its balance after the shock of the medical emergency. But there is no doubt that Beijing is also more constrained than it was 12 years ago. Not only is controlling new outbreaks of the virus a delicate task. There is also the fragile state of China’s financial system after years of stimulus. Huge risks are buried within China’s overgrown shadow banks and its bloated real-estate sector. Developers such as the hugely indebted Evergrande are disasters waiting to happen. Beijing may need to prioritize the health of its banks before it can press the economy’s accelerator pedal.
It also needs to consider the accumulation of relatively unproductive infrastructure that has burdened its economy with debt. And the People’s Bank of China will be mindful of the dramatic flight of money with which it struggled in 2015 and 2016, when it lost one-quarter of its giant reserves and was forced to dramatically tighten controls. Even then, it needed the help of the Fed, in the form of an accommodating interest-rate policy on the part of then Chair Janet Yellen. The Fed under its current chair, Jerome Powell, has been nothing but generous in its response to the crisis so far. U.S. interest rates are effectively at zero and credit is being pumped vigorously. That relieves pressure on Beijing to keep its interest rates high. But beyond that, China would clearly be unwise to assume that any stimulus on its part would be flanked by cooperation on the part of the administration of U.S. President Donald Trump. The Trump administration seems more interested in pinning the blame for the pandemic on China.
Given these constraints, it would be vain to expect China in 2020 to provide the locomotive force to pull the world economy out of recession. Indeed, China may find itself dealing with its own global debt crisis in microcosm. Prior to 2020, China had established itself as the major lender to the developing world. According to pre-crisis estimates, China had made foreign direct investment and direct loans equivalent to roughly 1.5 percent of global gross domestic product. Lending under the Belt and Road Initiative since 2013 had run to several hundred billion dollars. China was unusual precisely for its willingness to lend to poor countries which will be among the hardest-hit by the global downturn. How Beijing decides to treat that debt will be a telling test of the kind of hegemony to which it aspires.
Since the end of the Cold War, export-oriented emerging markets have flourished in a world in which they could arbitrage between an ocean of dollar funding, ample consumer demand in the United States, and China’s booming growth machine. Even before the coronavirus struck, that world was coming apart. The Belt and Road Initiative, Huawei, the South China Sea, trade wars, the politics of climate change and decarbonization—a whole series of wedge issues were forcing painful choices, and not just between the United States and China. Malaysia resentfully rejected the EU’s efforts to clean up the palm oil business. Brazil, while its farmers profited from the soybean war between China and the United States, was locked in a war of words with France over the Amazon rainforest.
Even if we can get through the next few months of acute threat remotely intact, the coronavirus shock will leave daunting problems of reconstruction. The medium-term outlook for emerging markets depends critically on how the world economy is put back together again.
Adam Tooze is a history professor and director of the European Institute at Columbia University. His latest book is Crashed: How a Decade of Financial Crises Changed the World, and he is currently working on a history of the climate crisis. Twitter: @adam_tooze