Emerging markets are suffering from what appears to be a “perfect storm” in recent weeks, with equities, bonds and currencies seeing declines, according to a new research note by the Institute of International Finance.
“Emerging market countries navigating harsh global economic and financial conditions must pursue strong economic policies to reduce vulnerabilities,” said Hung Tran, executive managing director of the IIF. “These countries will need to articulate a reform agenda designed to improve potential future growth.”
The IIF identified five factors that have combined to contribute to intensified headwinds to EM growth and prospects for financial markets:
- Portfolio rebalancing away from EM assets: Driven by a healing economy and anticipation of Fed liftoff, the U.S. dollar has strengthened by over 20 percent over the past three years, recently reaching 10-year highs on a trade-weighted basis. Together with expectations of rising U.S. rates, these developments have helped trigger a sustained rebalancing of international investors’ portfolios away from EM assets.
- Heightened refinancing risk: Many EM corporations have borrowed heavily in recent years. As the IIF noted in a recent research note, EM nonfinancial corporate debt has risen to 80 percent of GDP, up from 60 percent in 2008. Much of this debt may now not be hedged effectively against currency risk. The IIF calculated that only about 30 percent of EM non-financial corporate borrowers have natural hedges (e.g., exporters with U.S. dollar revenues). For many of these corporations, revenues have slumped along with export prices of late.
- Commodity price slump: A strengthening U.S. dollar continues to contribute to the multi-year decline in commodity prices, exacerbated in recent weeks by renewed concerns about China’s growth outlook. Sharp gyrations in Chinese equity prices and heavy-handed batteries of government support measures have raised concerns about China’s ability to engineer a soft landing and rebalance the economy. The willingness of the Chinese government to keep moving towards a fully market driven economy has also been called into question.