The emerging market crisis is coming back

Berlin, Sao Paulo, Istanbul, Kapstadt, Bangkok For years, the German mechanical engineering companies could look forward to the growth in their exports to Brazil, Mexico and India. Not so this year: exports all fell between 26 and 29 percent in the first seven months of the year.

John Floyd, head of macro strategy at investment firm Record Currency Management, speaks of “feedback mechanisms”. He assumes, for example, that the market turmoil in Turkey will soon also be reflected in the balance sheets of European banks, and is betting on falling prices for government bonds from Spain, France and Italy.

The indebtedness of the emerging countries has already reached alarming levels and has doubled to 72 trillion dollars since 2010, according to the IIF banking association. How many of the countries should be able to repay their debts, often in dollars, when their national currencies plummet, is questionable.

While the western industrialized countries are fighting against the coronavirus consequences with rescue packages worth billions and thus preventing the worst, the large emerging countries – with the exception of China – are helplessly exposed to the economic consequences of the pandemic – mainly because they cannot afford state aid on a western scale .

The crisis in the emerging countries, however, will hit the western industrialized countries, above all Germany, which has benefited for decades from the increasing demand for capital goods in the prosperous emerging markets.

For large corporations from Germany and other developed countries, sales markets are collapsing and transport routes are becoming less secure. “Worldwide, around 100 million people could fall back into extreme poverty,” warned World Bank boss David Malpass recently in an interview with the Handelsblatt.

At the autumn meeting of the International Monetary Fund (IMF) and the World Bank, the African countries will ask for an extension of the debt moratorium. The group of the 20 largest industrialized and emerging countries (G20) will probably extend their initiative to suspend debt servicing of developing countries beyond 2020.

The number of eligible countries now applying for debt relief has risen to 46 applicants, mostly from Africa, since April. So far, the initiative has helped 43 countries defer $ 5 billion in payments.
Such aid is not provided for the emerging economies that have made it into the middle class.

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The Federal Foreign Office worries that they will become developing countries again. “In addition to the demand and supply shock in these countries, there is a weak health infrastructure, high debt and, in some cases, severe devaluation of the local currency,” says Michael Hüther, director of the Institute for German Economy.

The Russian central bank is intervening again for the first time since 2014 against the fall in the local currency. Moscow’s gold and currency reserves are dropping billions every week.

Concerns about capital flight in Turkey

Capital flight is the greatest risk in the short term. In the early stages of the pandemic alone, investors withdrew $ 100 billion in foreign capital from emerging markets, the IMF estimates. “These are dimensions that have never been seen before,” says Klaus-Jürgen Gern, economic expert from the Kiel Institute for the World Economy. The IIF estimates that foreign capital flows to emerging economies (excluding China) could fall by more than half this year to $ 304 billion.

The example of Turkey shows what the collapse of the currency can do to an economy. In 2020, the Turkish currency lost 23 percent of its value against the dollar. High inflation and the central bank’s exhausted foreign exchange reserves are affecting the local currency. At the beginning of September, Moody’s Investors Service lowered Turkey’s credit rating deeper into the junk area and considers a balance of payments crisis “increasingly likely”.

A weak currency in an emerging country can also damage German companies, as products from Turkey – whether cherries or steel – compete against German companies at lower prices due to the exchange rate effect. In August, inflation in Turkey was almost twelve percent.

The Turks increasingly want to invest in hard currencies in view of the collapse of the currency. The weak currency puts the country’s companies in a mess. Because many companies have taken out loans in dollars or euros. And because of the weak exchange rate, they are constantly becoming more expensive for them in lira.

Policy failure in Latin America

Latin America has been badly affected in both the development of the pandemic and the economy. Latin America currently represents more than half of the officially registered corona victims worldwide. Of the ten countries in the world with the highest deaths per inhabitant, eight are from Latin America. Emerging countries like Brazil are also dependent on their income from raw material exports. Their prices have been in the basement since the beginning of the pandemic.

With a 5.2 percent slump in the economy this year, Brazil will get off relatively lightly. It is – and there is Brazil the big exception among the emerging countries – above all the high social compensation payments that have saved the largest economy in South America from a complete collapse.

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But that doesn’t go on forever. Brazil’s budget deficit will be around 16 percent of gross domestic product by the end of the year and its debt will grow to over 100 percent. Long-term interest rates are already rising on the financial markets. Foreign investors have withdrawn as much capital from the financial markets as they did during the 2009 financial crisis.

The government of right-wing populist Jair Bolsonaro does not dare to reform the administration and the tax system in order to cut spending and privileges, and is using trickery to increase spending without violating the budgetary limits.

This is fatal: “Brazil’s economic recovery depends crucially on the political credibility of the government in returning to financial and currency discipline,” says Cassiana Fernandez, Brazil analyst for JP Morgan.

So the uncertainty increases. The real has devalued sharply, the stock market has collapsed, and companies are cutting investments. “The economic uncertainty scares them off,” says economist Silvia Matos from the FGV University of Economics in São Paulo.
German industry is also feeling this.

There is particular concern for Argentina

After China, Brazil is the country with the largest German investments outside of Europe. They come primarily from the large German corporations in the automotive, chemical and technology sectors, but also from many medium-sized companies.

Berlin has already doubled its aid to Latin America this year – also in its own interest. According to the Foreign Office, the volume of trade with Latin America is twice as high as compared to Africa or India in terms of residents.

In Mexico, an important foreign market for German industry, industrial production fell by more than 13 percent between January and August. There is particular concern about Argentina: the economy there will shrink by 12.4 percent. The government has imposed the longest lockdown in Latin America since March, which will last at least until mid-October. “GDP will not return to pre-pandemic levels until the end of 2023,” says Pamela Ramos from Oxford Economics.

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President Alberto Fernández has no plan for overcoming the economic crisis. The central bank has only two billion dollars in its foreign exchange coffers. The government finances 60 percent of its state expenditure with the printing press. The consequences: According to the tax authorities, 24,500 companies have closed since the beginning of the year.

Around a dozen large foreign companies have announced their plans to leave the country: airlines such as Latam, the fashion chain Falabella, Walmart, but also several automotive suppliers. Including the BASF with their lacquer and paint production.

Indian public finances at the limit

In India, which was still the world’s fastest growing economy in 2018, economic output is likely to shrink by 9.5 percent in the current financial year, the central bank predicts. In the fight against the worst economic crisis in decades, India’s government is running out of time from the perspective of one of the country’s best-known economists.

“Without support measures, the economy‘s potential for growth will be seriously damaged,” warned Raghuram Rajan, who previously headed India’s central bank and previously worked for several years as chief economist of the International Monetary Fund. Even the ten billion dollar economic stimulus program announced on Monday failed to convince the financial markets.

India’s state aid packages are extremely tight by international standards. One reason for Modi’s reluctance is the strained public finances, which left little room for additional government spending even before Corona: According to the Fitch rating agency, the national debt was 71 percent of gross domestic product in 2019. According to calculations by Fitch, India’s debt level is likely to rise further in the next two years – to almost 90 percent of economic output.

Modi’s government is facing a balancing act with a high risk of falling: India’s ability to achieve both a sustainable budget and steady economic growth in the future is under threat, the rating agency S&P notes.

The fact that India is finding its way back to its old strength is also in the interests of the German economy. Most recently it exported goods worth almost twelve billion euros to India – making the country Germany‘s most important sales market after China among Asia’s emerging economies.

40 percent unemployed in South Africa

Hardly any other emerging country has been hit as hard by the corona crisis as South Africa. The fatal development there is also due to the fact that the country was already in dire economic straits before the outbreak of the pandemic. The lockdown severely damaged the tourism sector, which creates around 1.5 million jobs and contributes a good eight percent to the economic output of the Cape Republic.

Although South Africa reopened its national borders on October 1st, tourists from important travel countries such as Great Britain, the USA, Switzerland, but also Holland are not allowed to travel there due to the Corona situation.

Even before Corona, the country experienced the second recession in just two years. The gloomy situation has now grown into a “disaster”, says economist Mike Schussler. According to Finance Minister Tito Mboweni, the only real reformer in the cabinet of Head of State Cyril Ramaphosa, the South African economy will shrink by more than the previously predicted seven percent in 2020.

Many analysts expect a double-digit decline. In the second quarter, GDP had already slumped by an unprecedented 51 percent.

The already high unemployment of 30 percent could rise to 40 percent in the short term, experts expect. That puts an enormous strain on public finances. The Treasury now expects a budget deficit of 15.7 percent – more than twice as much as recently thought. The country is already spending more than 20 percent of its budget on debt servicing alone.

The international institutions have recognized the seriousness of the situation; even in the rich north, the dimension of the emerging market problem is becoming clearer every week, in which the recovery of the economy in the industrialized countries is made more difficult by feedback.

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