After a strong start earlier this year, capital flows into emerging markets fell to zero in the third quarter, according to a new report from the Institute of International Finance (IIF). At the same time, many EM central banks have deemed it necessary to curtail spending and increase interest rates despite the backdrop.
“They definitely feel pressured by the market,” Elina Ribakova, IIF’s deputy chief economist, told GlobalMarkets. Even countries with commodity windfalls or strong fundamentals are tightening fiscal and monetary policy despite a limited economic recovery. “I was surprised to see countries like Chile pressured by the market on the fiscal policy front, Colombia too,” Ribakova added.
At a time when developed nations are using their central banks to monetize debt, rate hikes and deficit reductions will make it harder for emerging markets to protect their economies from permanent damage. It will also distract policymakers from what the IIF deems the greatest long-run concern in EM: preventing secular stagnation from draining growth. Excluding China and India, the institute finds that growth across the rest of EM has failed to “meaningfully” outperform developed markets in close to a decade.
The EM space has become far more varied in terms of growth models, income levels and sheer geography. But whether you are services-focussed or export-oriented, no one is safe from secular stagnation. Certainly not gas exporters watching spreads tighten in the secondary market. “Russia and Qatar are having a great time,” said a London-based EM investor speaking to GM’s sister newspaper GlobalCapital. But the fundamental story is different. The IIF expects Qatar’s GDP growth to reach only 3.1% and 3.8% in 2021 and 2022 respectively, well below mature market growth rates. (IIF numbers only partially take into account the recent gas price moves, although the institute believes recent price surges will have a minimal effect on Russian GDP.)
Russia’s tightening debt spreads are down to sanctions limiting the volume of Russian debt available, and a gas price spike that EM investors expect to last for only six months or so. Over the longer term, Ribakova puts Russia together with countries like Brazil and South Africa that are getting stuck on the productivity ladder.
“We will see an interesting phenomenon in the near-term that is somewhat counterintuitive,” she said. “Some [of these countries] might come out as short-term beneficiaries, but this is a balloon that will pop.”
Frontier opportunity
One group of countries that could benefit from the secular stagnation trend elsewhere in EM are frontier markets. Ribakova said that getting investors into a room with frontier market representatives used to be a challenge — now there are too many people signing up for meetings. This could benefit countries like Malawi, desperately seeking private sector investment as well as concessional IFI funding to recover from the pandemic and drive sustainable growth.