The Economist UK: Contagion has not triggered emerging market crisis

Reference News (Oct. 23, 2009) reports that the following is an excerpt from the article “New Coronary Pneumonia Has Not Yet Caused an Emerging Market Crisis – But the Possibility Exists” published on the website of the British weekly The Economist (Oct. 10, 2009).

Poorer countries are more dependent on trade than richer countries, especially on tourism and commodity exports. In these countries, there are fewer professional and technical jobs that can be done from home, and the cost of social isolation is therefore higher. Since governments and businesses in these countries borrow frequently in US dollars, they often suffer from the depreciation of the local currency against the US dollar in times of economic stress. This creates inflation and makes it more difficult to support the economy by lowering interest rates. Governments in these countries are also less able to borrow for emergency medical expenses, or to bail out workers and businesses. The pandemic seemed certain to plunge them into financial turmoil.

Yet it proved easier to contain the financial crisis than to control the disease. The neo-crown virus that has ravaged middle-income countries such as Brazil, India and South Africa has collided head-on with poverty and flawed health care systems. This year, emerging markets are likely to see the sharpest contraction in gross domestic product on record. India’s output in the second quarter fell by almost a quarter year-on-year, which is alarming.

But the International Monetary Fund (IMF) said these countries can basically continue to finance from capital markets, raising $124 billion in the first half of 2020. The IMF has provided $89 billion in loans to financially troubled countries – compared to periods such as the financial crisis, the 2013 “tapering scare” and the 2018 stock market sell-off – and is now putting less pressure on local currency and foreign exchange reserves. -That’s a lot of money, but only a fraction of the agency’s $1 trillion “ammunition”. Some had warned in the spring that the IMF’s lending line might run out.

Much of this resilience can be attributed to the Fed, which in the spring eased the global tightening in the dollar market. The Fed was able to do this, in part, by providing dollars directly to some emerging markets: Brazil, Mexico, Singapore and South Korea received currency swap lines, and most central banks were temporarily allowed to swap long-term U.S. Treasuries for cash. But as with many of the Fed’s interventions, just releasing a lifeline may have bolstered confidence. The aforementioned Treasury program has barely been touched.

The easing of pressure on the dollar created room for stimulus measures. Emerging markets have implemented fiscal plans that total about 3 per cent of GDP. Brazil distributed a monthly dole of 600 reais ($110) to nearly a third of its citizens.

But most notably, emerging markets adopted unconventional monetary policies, inspired by the central banks of rich countries. It’s a bit odd that more than a dozen countries have implemented some sort of bond-buying program, including Turkey, Mexico and South Africa, which still have room to cut interest rates. But a report from the Bank for International Settlements shows that the bond purchases have eased financial conditions and supported emerging market currencies without undermining confidence.

However, it’s still too early to be optimistic. Many economists remain concerned about a wave of sovereign and corporate bond defaults in some large emerging markets and the possibility of a financing crisis. Emerging market attempts at unconventional policies may ultimately fail. It is also possible that the virus could continue to wreak havoc.

In a recent article, economists Jeremie Blow, Carmen Reinhardt, Kenneth Rogoff and Christoph Trebesch warned: “History shows that it is not uncommon for countries to continue to borrow money even when the risk of default is high.” And the IMF says that without more help, the poorest countries will set back their performance on poverty reduction by 10 years.