Can emerging market governments weather global pressures?

This is a very troubling time for emerging markets, thanks to factors such as the strength of the US dollar, writes CHRIS HATTINGH.

Along with their own debt repayments (and the interest thereon) taking an upward trend, emerging market governments are under escalating pressure from the increasing strength of the US dollar. Many of these governments have been unable to provide support and stimulus comparable to developed economies; calls are mounting for them to increase their spending as the world emerges from Covid-19 and its associated lockdowns.

The major risk is that, should these governments take on more loans and debt to fund more infrastructure and welfare spending, they will expose their citizens to future crises, as is currently taking place in Sri Lanka. A likely low-growth economic environment for the next few years means that governments will collect less tax revenue. In turn, they will simply not have the funds available to spend on large-scale infrastructure projects and welfare programmes.

According to Bloomberg, emerging market governments are “burning through the equivalent of more than US$2 billion in foreign reserves every weekday in an attempt to prop up their currencies against the dollar”.

In total this year, they have collectively drained reserves – the emergency stash held to fend off severe economic crises – by US$379 billion. As the dollar strengthens, and a given government has more debt in those terms, it will become increasingly difficult for them to repay that debt.

Bloomberg highlights that 36 currencies worldwide have lost at least 10% of their value in 2022. Ten of these currencies, including the Sri Lankan rupee and Argentine peso, are down more than 20%. Inflation generally eats away at the value of a currency and the spending power thereof, which in concrete terms means that consumers’ money does not buy as much for them as it did previously. Some families and individual consumers will be able to find room within tighter budgets to keep some of their spending priorities; others will need to radically change their spending patterns to focus on their highest needs.

It is very likely that the US Federal Reserve will continue to hike interest rates through the second half of this year, and at least into the first half of 2023 as well. In its mission to combat red-hot inflation, the Fed will therefore continue to strengthen the dollar. That some emerging markets could experience currency crises (and down the line, debt crises) becomes an ever greater possibility.

Currency and debt crises bring with them serious socio-political instability, protests, and in some cases violent uprisings. Citizens see their savings and spending power effectively wiped out as their currency becomes worth little, and many will take to the streets to vent their frustration and their sense of lost power and agency.

It is worth noting too that some governments will have shifted to the Chinese yuan as a possible safe haven, given the rampant pace of the dollar so far this year. The Chinese economy has, however, largely struggled to get going this year; in the last two months especially, the yuan appears to be under serious pressure and is now at a two-year low.

August marked the sixth consecutive month of decline for the yuan. The government’s zero-Covid policy stance (with repeated lockdowns) and a looming property crisis are large risk points for the Chinese economy. In 2021 China represented 20% of South Africa’s exports; its importance was even greater for Brazil, at 34.4%. Should Chinese economic activity not recover and progress substantively through 2023, South Africa will feel the negative consequences thereof.

If a given country’s currency weakens very quickly, and it also sells dollars it has in reserve, this sends a signal to investors that will negatively affect the government’s ability to borrow from international lenders. This will also impinge on their access to international capital markets. Countries that are more reliant on imports (especially manufactured components and finalised products) will find themselves paying more for said imports. The longer-term consequence is once more depressed economic activity and growth, combined with lower amounts of saving.

Capital flowing into emerging markets is currently at the lowest level since the period just after the start of the Covid-19 pandemic. Emerging market governments that implement pro-economic freedom reforms will be better able to attract foreign capital and investment, and in so doing secure continued access to international markets.