World Economy

EMs Face Credit Challenges

Emerging countries will be affected when interest rates go up. They will be even more affected if liquidity dries up
Turkey will have the widest current account deficit this year at 4.5% of GDP, followed by Argentina and Colombia.
Turkey will have the widest current account deficit this year at 4.5% of GDP, followed by Argentina and Colombia.

As the US and European countries embark on a monetary tightening cycle, emerging economies could be hit by a liquidity squeeze, a European official in charge of financial stability says.

"Those have to be careful—who have debt in foreign currencies and who have sizable current account deficits, and therefore continuously need inflow of foreign capital," said Klaus Regling, managing director of the European Stability Mechanism, in a recent interview, Nikkei reported.

The ESM is an intergovernmental organization set up in 2012 to ensure financial stability in the eurozone. Regling said the vulnerable emerging economies are in Asia, Latin America and Africa.

"Monetary policy is now in a tightening mode. That will make central banks' task more difficult," Regling said. "Emerging countries will be affected when interest rates go up. They will be even more affected if liquidity dries up, which I don't see at the moment."

Monetary tightening could also slow economic growth in developed countries. The European Union reported growth of 2.5% in 2017, the highest rate in 10 years, but the ESM chief said that pace is difficult to maintain.

"We have to be aware that this high-growth performance will not last for very long. One has to prepare for a slowdown. Not a crisis, but for a normal cyclical slowdown," he said.

The ESM was set up after the global credit crisis and the European debt crisis that crippled several European countries, including Greece, which is now the only country still in the ESM's rescue program. But Regling expected Greece to exit its bailout program in August.

Referring to Greece, Regling said: "Competitiveness has returned, and exports are having a good effect on the current account balance. The aim is now to strengthen the potential growth rate of Greece."

But whether Greece can maintain its economic and fiscal soundness on its own is unclear, and Regling did not rule out the possibility of further Greek debt relief.

China would be especially interested in such news. Beijing has invested heavily in Greece, including in Piraeus Port, as part of its Belt and Road Initiative.

Investment Tools

For the rest of Asia, the ESM is an important provider of investment tools. ESM funds its financing programs through bond issuance, and outstanding ESM bonds currently amount to about €270 billion ($332.5 billion). Asian investors hold about 15% of these bonds.

"Some Asian investors who have left (euro assets) during the crisis are now coming back. They are not only buying the ESM bonds but also bonds in all European countries," Regling said.

The ESM does want to broaden its investor base. It issued its first non-euro bond in dollars last December. "Institutionally and legally, we could also issue in other currencies," he said. "Yuan and yen are possibilities, but also Swiss francs or British pounds."

But the ESM has no plans for any issuance for now, he said.

Asia Among Least Vulnerable

The specter of volatile financial markets is prompting investors to be more selective in emerging markets and Asia is stacking up to be among the most resilient when it comes to economic measures, Bloomberg said.

Among the 22 developing economies, Taiwan and Thailand come out on top in terms of current-account balances, while Brazil and Hungary are projected to have the largest debt pile, data compiled by Moody’s Investors Service show.

“Emerging-market assets have been bought as a bulk, but not every economy will continue to attract foreign investors from here,” said Tsutomu Soma, general manager of SBI Securities Co.’s independent financial advisor department in Tokyo. “Asia stands out both politically and economically. Latin America and Europe face political issues, while the Middle East’s got geopolitical risks.”

While emerging-market assets have recovered some of their losses from the February rout, another bout of volatility could be just around the corner as US benchmark treasury yields rise to near 3% amid prospects for tighter monetary policy by the Federal Reserve. The MSCI Emerging Markets Index of shares is headed for a second weekly gain, rising 1% so far this week.

Turkey will have the widest current-account deficit this year at 4.5% of gross domestic product, followed by Argentina and Colombia, according to Moody’s. By contrast, Taiwan, Thailand and South Korea will have the biggest surpluses, exceeding 5% of their GDPs.

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