Emerging Markets: This is not 1997 again

Emerging Markets: This is not 1997 again

Macro
Christopher Dembik

Head of Macroeconomic Research

Summary:  The current weakness in emerging markets is a clear indicator that the global credit cycle is turning down and that more headwinds are coming.


Since mid-April, emerging market currencies have fallen sharply versus the USD. The most significant drops have been experienced by the TRY (-58%), BRL (-22%), ZAR (-20%) and RUB (-15%).
Depreciation versus USD
The current weakness in emerging markets is a clear indicator that the global credit cycle is turning down and that more headwinds are coming.

Since the Great Financial Crisis, an excess of liquidity has supported global growth and flowed to emerging countries, leading to an increase of debt. Over this period, US-denominated debt has increased by 152%, which represents more than $2 trillion.

Foreign debt to EM by currency denomination
Due to monetary policy normalisation, liquidity has been drying up since the beginning of this year. Our model of global USD money supply based on the 25 largest economies reached a peak in January 2018 and is now at its lowest level since Spring 2017. 

The dollar liquidity squeeze along with global tightening financial conditions drives higher funding costs in EM. The most vulnerable countries are the ones with high current account deficits (meaning they are heavily dependent on foreign funding) and high levels of USD-denominated debt.

A break of the Dollar Index above the 95 level, like the one seen this past summer, would add more pain to EM as it would signal that servicing greenback loans is getting more and more expensive. It would certainly constitute a strong risk-off signal and cause more capital outflow from EM.

The downward USD liquidity trend can only be reserved by stronger growth or central bank stimulus, which are both very unlikely in the medium term. 
USD liquidity indicator
Turkey has been the first domino to fall. The country shares a lot of similarities with Thailand in 1997, which at that time faced an external debt reaching 65% of GDP coupled with a currency crisis and a sudden loss of investor confidence. Turkey’s external debt is about 56% of GDP and its short-term US-denominated debt currently sits at its highest-ever level around $200 billion. Its currency has been falling sharply while political risk has pushed away foreign investors. 

The only bright side, and one that we didn't see in 1997's Thailand and don't see in the ongoing Argentinian crisis is that Turkish residents are repatriating foreign assets to deal with this tricky external funding picture, which will bring some support in the short term.
Turkey current account balance
Is another, 1997-style emerging country crisis on the cards? It's unlikely. Not all emerging countries, after all, are equal; we notice that countries with better GDP readings and current account positions are less exposed to the current headwinds. Trade openness is also a key criterion that has more influence than it did in 2013 when the Fed taper occurred.
Current account balance as % of GDP
EMs that have reduced reliance on FX debt have demonstrated better resilience than others other the past few months. These efforts are particularly striking in CEE, especially in Poland and in Hungary where FX-denominated debt has decreased by roughly nine percentage points since the end of 2016. 
Change in EM FX-denominated debt
Contagion has largely been contained globally, expect for countries with high political risk situations (Argentina, Brazil, South Africa, and Turkey). Rising political risk has acted as an aggravating factor for investors. 

Of these four countries, Brazil seems to be in the best economic shape. Its current account deficit stands at only 1% of GDP and it has enough foreign reserves (at $367bn) to efficiently defend its currency. The only negative macro data are linked to the high level of public debt, but since this is owned mostly by domestic holders (95%), the risk is more limited. 

In addition, the latest economic data, especially leading indicators such as the Itaú Monthly GDP reading, tend to confirm economic activity is set to accelerate slightly. We believe that the current vulnerability seen in Brazil will prove short-lived as it is essentially a consequence of uncertainty surrounding the upcoming October election (the first round of voting is on October 7 and the second on October 28).
Brazil: Itau monthly GDP index vs. real GDP
By contrast, tougher days might be coming for South Africa. The honeymoon between President Ramaphosa and investors is definitively over. The country plunged into technical recession in Q2 for the first time since 2009 and political risk keeps rising due to the land reform programme that should be formally implemented at the beginning of next year. 

This agrarian reform has a massive knock-on effect on investors and South Africa is not well-prepared to deal with its negative consequences. The country’s current account deficit has narrowed since 2014 but still stands at 3.2% of GDP, and South Africa does not have enough currency reserves to defend the rand against any prolonged period of speculation. Despite a year-on-year increase of 1.9%, South Africa's international reserves stand at just $42bn, the equivalent of five months' worth of imports.
South Africa current account balance
Looking at EMs as a whole, we have seen a sharp economic transformation over the past decade. The main vulnerability still comes from these countries' strong reliance on USD funding, which has considerably increased since 2008.
 
many EMs, however, notably those in Southeast Asia, face fewer domestic imbalances than in 2013 or in the late 1990s, making them more resilient to the global QE exit and lower USD liquidity. The most fragile countries are those with weak fiscal positions and high political risk. After Turkey and Argentina, South Africa could face higher tensions. On the other hand, the situation should quickly stabilise in Brazil once the election has passed. So far, there is no risk of contagion to any other EM economy. 

Quarterly Outlook

01 /

  • Equity outlook: The high cost of global fragmentation for US portfolios

    Quarterly Outlook

    Equity outlook: The high cost of global fragmentation for US portfolios

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: Commodities rally despite global uncertainty

    Quarterly Outlook

    Commodity Outlook: Commodities rally despite global uncertainty

    Ole Hansen

    Head of Commodity Strategy

  • Upending the global order at blinding speed

    Quarterly Outlook

    Upending the global order at blinding speed

    John J. Hardy

    Global Head of Macro Strategy

    We are witnessing a once-in-a-lifetime shredding of the global order. As the new order takes shape, ...
  • Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Quarterly Outlook

    Asset allocation outlook: From Magnificent 7 to Magnificent 2,645—diversification matters, now more than ever

    Jacob Falkencrone

    Global Head of Investment Strategy

  • Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    Quarterly Outlook

    Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?

    John J. Hardy

    Global Head of Macro Strategy

  • Equity Outlook: The ride just got rougher

    Quarterly Outlook

    Equity Outlook: The ride just got rougher

    Charu Chanana

    Chief Investment Strategist

  • China Outlook: The choice between retaliation or de-escalation

    Quarterly Outlook

    China Outlook: The choice between retaliation or de-escalation

    Charu Chanana

    Chief Investment Strategist

  • Commodity Outlook: A bumpy road ahead calls for diversification

    Quarterly Outlook

    Commodity Outlook: A bumpy road ahead calls for diversification

    Ole Hansen

    Head of Commodity Strategy

  • FX outlook: Tariffs drive USD strength, until...?

    Quarterly Outlook

    FX outlook: Tariffs drive USD strength, until...?

    John J. Hardy

    Global Head of Macro Strategy

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

None of the information provided on this website constitutes an offer, solicitation, or endorsement to buy or sell any financial instrument, nor is it financial, investment, or trading advice. Saxo Capital Markets UK Ltd. (Saxo) and the Saxo Bank Group provides execution-only services, with all trades and investments based on self-directed decisions. Analysis, research, and educational content is for informational purposes only and should not be considered advice nor a recommendation. Access and use of this website is subject to: (i) the Terms of Use; (ii) the full Disclaimer; (iii) the Risk Warning; and (iv) any other notice or terms applying to Saxo’s news and research.

Saxo’s content may reflect the personal views of the author, which are subject to change without notice. Mentions of specific financial products are for illustrative purposes only and may serve to clarify financial literacy topics. Content classified as investment research is marketing material and does not meet legal requirements for independent research.

Before making any investment decisions, you should assess your own financial situation, needs, and objectives, and consider seeking independent professional advice. Saxo does not guarantee the accuracy or completeness of any information provided and assumes no liability for any errors, omissions, losses, or damages resulting from the use of this information.

Please refer to our full disclaimer for more details.

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992