EM braces for more pain as risks increase

Emerging markets (EM) have long struggled to contain the financial turmoil that has hit them amid the US Federal Reserve’s focus on tightening financial conditions.
To tame rising prices, the Fed is embarking on its most aggressive round of interest rate hikes in two decades, helping to push the dollar higher and other currencies lower.
The fallout from a mix of external shocks and growing financial difficulties is sweeping through low- and middle-income countries, creating perhaps the greatest confluence of challenges since the 1990s, when a series of successive crises sank economies. and overthrown governments.
Unrest fueled by rising food and energy prices is already gripping countries such as Sri Lanka, Egypt and Peru.
A post-pandemic inflation spurt is a source of tension in countries that need US dollars for energy, medicine and food imports.
Food costs account for around 40% of consumer spending in places like sub-Saharan Africa, more than double the share of advanced economies.
The current dynamics may trigger panic attacks among international investors and sudden capital outflows from the most exposed countries.
Sri Lanka is seen as a prime example of how food and fuel shortages can turn into violent street protests and destabilize an unpopular government.
The South Asian nation defaulted on its foreign debt in May for the first time since gaining independence from Britain in 1948.
According to Bloomberg Economics, a handful of other countries, including Pakistan, Tunisia, Ethiopia, Ghana and El Salvador, were likely to follow suit.
Emerging market stocks have fallen below their average valuations of the past 17 years.
With a $5 billion equity rout and 15 months of capital outflows, emerging markets are at an advanced stage of risk assessment. Still, the risk of larger losses remains, especially if the Chinese economy slows further or the Fed becomes more hawkish.
The combined values ​​of stocks in the 24 countries classified as emerging markets by MSCI Inc have fallen $4 billion from a peak in early 2021, while the Bloomberg gauges of dollar bonds and local currency debt have lost $500 billion. dollars each from their highs.
Political and business leaders gathered for the World Economic Forum (WEF) gathered on Monday against the backdrop of inflation at its highest level in a generation in major economies including the United States, Britain and Europe.
International Monetary Fund Managing Director Kristalina Georgieva said the war, tighter financial conditions and price shocks – for food in particular – have clearly “clouded” the month’s outlook since, although she don’t expect a recession yet.
The World Bank mobilized a $170 billion crisis response program in April, more than the $157 billion spent on its initial Covid-19 response. More countries have started bailout talks with the IMF.
The deepest problems in emerging markets stem from the excessive financialization of the global economy that has occurred since the 1990s.
The resulting political dilemmas – growing inequality, increased volatility, reduced room for maneuver to manage the real economy – will continue to preoccupy policymakers for decades to come.
Of course, Western central banks will no longer pump easy money. Thus, emerging economies must seek investment liquidity at home.
Without a strong local investor base, backed by forward-looking policy initiatives and structural reforms, countries risk reverting to the old boom and bust cycles of the 20th century.
And part of the challenge will be to rebuild the macroeconomic buffers that have been depleted during years of fiscal and monetary stimulus.