The Covid-19 Crisis: Emerging Markets Hang in the Balance

“All countries need to work together to protect people and limit the economic damage. This is a moment for solidarity.”

Kristalina Georgieva Managing Director and Chairwoman of the IMF

The COVID-19 crisis has already left some of the world’s most advanced economies in dire straits. News outlets have been quick to cover the stringent lockdowns and plummeting markets of the developed world. However, media coverage of emerging markets (EMs) has been less comprehensive. For these nations, the outbreak will likely be even more devastating – both in economic and health terms. Capital flight from EM economies has exceeded $90bn in a matter of months. Incomes have been squeezed by collapsing commodity prices, falling domestic demand and lower remittances. Whereas Western economies have started to re-energise demand with large support packages, EM governments don’t have as much fiscal flexibility. At the same time, vastly inadequate healthcare systems will be unable to cope with high infection rates. The situation is not promising. The only respite for many EM nations is the potential for foreign aid. The IMF has already made $50bn available for developing nations and is preparing to mobilise its $1tn lending capacity. But even this won’t be enough: Kristalina Georgieva estimated that the required figure is closer to $2.5tn. It is very likely that EMs will experience their slowest growth rates since the 1997 Asian financial crisis.

However, the crisis won’t affect all EM nations equally. The extent of the economic damage will depend on three factors. First, the robustness of healthcare systems will be increasingly important. Many developing nations suffer from a lack of essential medical equipment. On top of high death rates, these nations will experience more capital outflows and market disruption. Second, the expected persistence of low oil and commodity prices will damage many EM economies. Following the Global Financial Crisis (GCF), commodity prices rapidly recovered between 2009 and 2011. This recovery acted as a boon for emerging markets which relied on the sales of commodities to finance their overseas borrowing. In the current crisis, however, commodity prices – especially oil – are unlikely to recover quickly. The global oil landscape has been fundamentally changed by the standoff between Russia and Saudi Arabia over production cuts, with prices dropping below $25 a barrel: an 18-year low. Other commodities have also suffered both supply and demand side shocks, with copper experiencing a 4-year low in mid-March. These low prices will squeeze incomes for many EMs. Third, governments with more fiscal space will inevitably be better positioned to weather the economic crisis by boosting domestic demand. They can also spend more to improve healthcare levels.

Considering these factors, many industrialised Asian EMs are in a significantly better position. China is especially well placed as it has already managed to contain the virus. South Korea has a particularly strong healthcare system with 12.3 hospital beds per 1,000 inhabitants – the second highest in the world after Japan. Countries such as Taiwan and Thailand have similarly solid healthcare. They also are net importers of oil and other industrial commodities and will benefit from cheaper prices. Furthermore, as net creditors to the rest of the world, they have resources to finance fiscal stimulus. It is likely that these nations will follow China’s v-shaped recovery. Eastern European nations are also likely to recover well for similar reasons. Areas of more concern are India, Southeast Asia, South America, Middle East and Africa. In South Africa, for instance, the healthcare system is stretched under normal circumstances with 7.7 million living with HIV. It will be pushed beyond its breaking point as the virus continues to spread, especially as the prevalence of slums makes social distancing virtually impossible. On top of this, the rand is collapsing and sovereign debt has been downgraded by rating agencies to ‘junk’ status. Many EMs are in a similarly perilous situation. Nations with a heavy reliance on oil (e.g. Venezuela) or tourism (e.g. Mexico) will especially suffer as balance of payment pressure mounts.

Is there any hope for these nations? They will certainly struggle to remedy the situation with the macro policy tools currently available. Fiscal guns around the world are rapidly running out of ammunition and interest-rate cuts seem ineffective at boosting demand. Interest rates are often so low that they don’t even compensate for inflation (see figure 1); this adds an incentive for foreign firms to pull out, worsening capital outflows. Financial aid from the World Bank and IMF will be essential, but as mentioned, not enough. Fortunately, developed nations are offering other support programs. The U.S. Federal Reserve has opened nine new swap lines with foreign central banks and have initiated a new repurchase facility. These programs will allow EM central banks more dollar liquidity. There is also some hope that plummeting exchange rates will actually hasten EM recoveries because currency depreciation makes exports more competitive and often reduces the burden of sovereign debt. Furthermore, policymakers are experimenting with quantitative easing: central banks in Indonesia, Poland, and South Africa (among others) have started buying bonds to pump cash into their markets. These programs may very well be effective, but they still won’t be enough. In this truly global crisis, economic cooperation must extend beyond developed borders. Strong EMs mean stable supply chains. Even if developed markets recover quickly, growth will continue to lag if EMs are still suffering. EMs will also not forget which nations came to their aid. China is increasingly providing economic assistance; the West must do the same if it wants to retain its geopolitical influence. It is not only a moral imperative. EMs in crisis lead to increased regional conflicts, uncontrolled immigration and climate change challenges. This would be to the great detriment of the whole world.