Three threats to growth in emerging markets

THE NEWS, as the second anniversary of the pandemic nears, could be better. The emergence of a covid-19 variant, labelled Omicron, has sparked a wave of selling on financial markets, seemingly on concern that a new highly transmissible strain of the virus could set back economic recoveries worldwide. With luck, Omicron may prove manageable. But continued disruptions from various variants of covid-19 represent just one of three formidable forces that will squeeze emerging markets in 2022, alongside tighter American monetary policy and slower growth in China.

Start with American policy. Markets knocked for a loop by Omicron sagged further on November 30th, after Jerome Powell, the chairman of the Federal Reserve, suggested that the central bank might accelerate its plan to taper its asset purchases. Thanks to the critical role of the dollar and Treasury bonds in the global financial system, a more hawkish Fed is often associated with declining global risk appetite. Capital flows towards emerging markets tend to ebb; the dollar strengthens, which, because of the greenback’s role in invoicing, reduces trade flows.

In order to assess which places face the biggest squeeze from a tightening Fed, The Economist has gathered data on a few key macroeconomic variables for 40 large emerging economies (see chart 1). Large current-account deficits, high levels of debt (and of that owed to foreigners especially), rampant inflation and insufficient foreign-exchange reserves are all indicators that can spell trouble for countries facing fickle capital flows as American monetary policy tightens.

Combining countries’ performance on these measures yields a “vulnerability index”, on which higher scores translate into greater fragility. Some places are already in serious trouble. Argentina, which tops the list, faces an inflation rate above 50% and a deepening economic crisis. Turkey’s fundamentals look a little better, but its woes are compounded by the government’s stubborn desire to lower interest rates in the face of soaring prices. The lira has been hammered, losing 45% against the dollar in 2021, diminishing the purchasing power of Turks’ wages and pensions.

The second element of danger comes from China’s slowing economy. When China falters, exporters around the world feel the pain. It is, by a large margin, the world’s biggest consumer of aluminium, coal, cotton and soyabeans, among other commodities, and a major importer of goods ranging from capital equipment to wine.

Ranking the same 40 economies by their exports to China, as a share of their own GDP, yields an index of vulnerability to the country. Many of the biggest exporters to China, like Vietnam, are critical links in manufacturing supply chains, which should be untroubled as China’s domestic economy slows, as long as Americans keep shopping and Sino-American trade relations stay stable. At greater risk are the poorer commodities exporters that have helped feed China’s population and provide for its building boom.

This gauge of exposure to China can then be compared with our measure of vulnerability to American monetary-policy tightening (see chart 2). Some countries’ fates are more linked to one of the giants than the other. An unlucky bunch, such as Brazil and Chile, appear most likely to suffer from a double whammy. Despite high levels of debt and soaring inflation, high commodity prices have enabled Brazil to just about maintain investors’ confidence. A softening Chinese economy could deprive Brazil of that benefit, leading to a tumbling currency, even higher inflation and the possibility of economic crisis.

The world has faced the combined pressure of hawkish American policy and a stumbling China before. In the mid-2010s fragile emerging markets were squeezed by a rising dollar, as the Fed withdrew the monetary support provided during the global financial crisis, while a badly managed round of financial-market liberalisation and credit tightening triggered a slump in China. Growth across emerging markets, excluding China, sagged from 5.3% in 2011 to just 3.2% in 2015.

The squeeze this time is almost certain to be worse. That is in part because the Fed is expected to tighten policy more quickly than it did in the 2010s, when a weak recovery and stubbornly low inflation forced it to go slow. Then more than two-and-a-half years elapsed between the Fed’s announcement of its intention to reduce its asset purchases and the first rise in its policy rate. This time, by contrast, the 12 months following the Fed’s announcement of its plan to begin tapering in November are likely to involve a complete halt to bond-buying and, according to market pricing, at least two interest-rate rises.

China, for its part, also seems at greater risk of a hard landing today than it was a half-decade ago. Most economists thought growth would slow to 4.5-5.5% even before the emergence of Omicron. That would, with the exception of 2020, be the lowest growth rate since 1990.

Another reason for the pain this time around is the addition of a third hazard to emerging markets: the spread of Omicron and the risk of future variants. Little is yet known about the danger posed by Omicron. But the emerging world remains particularly vulnerable to nasty outbreaks of the virus. With a few exceptions, vaccination rates in poorer countries lag behind those in rich ones. Just a tenth of Africa’s population has received even one jab, less than the share of Americans that has received a third shot. Of our group of 40 countries, vaccination rates are particularly low in Egypt and Pakistan, two countries that are also especially vulnerable to American monetary tightening.

The spread of a new variant against which existing vaccines may be less effective could prove back-breaking to tourism-dependent economies. And public purses in the emerging world more broadly are in no fit state to extend or reintroduce pandemic relief measures.

Working out how the three threats might interact with each other is tricky. But it is possible that their coincidence could lead to still more economic pain for poorer countries. Unforgiving capital markets as the Fed tightens could leave emerging-market governments fiscally hamstrung in the face of new outbreaks. Omicron-induced local lockdowns in China could deal emerging-market exporters another blow. The tourist-dependent countries of South-East Asia, once popular destinations for Chinese visitors, are likely to remain deserted for a while longer.

The pandemic’s third year was already destined to be a rocky one for emerging markets, stuck as they are between the two poles of a tightening America and a slowing China. New variants could make the journey still more perilous. ■

To keep up with our latest coverage on the spread of the Omicron variant go to economist.com/omicron

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