Rising Risks in Emerging Markets
As the Coronavirus pandemic has spread worldwide, emerging markets have been severely damaged. Credit risk, market risk, operational risk, liquidity risk and other unknown risks are rising rapidly in most emerging countries.
In order to survive the public health crisis, all countries are raising their debt levels.
Emerging markets as a whole owe a total of $71 trillion. This enormous sum has been accumulated over the last decade due to the demand for construction and infrastructure development.
Now the problem arises: are these emerging nations able to pay their debt?
The emerging markets are facing three big challenges: a significant shortcoming of healthcare resources, an economic recession, and capital outflow. The high population density countries such as India are struggling due to the infeasibility of social distancing. Global unemployment is rising dangerously, even the US has seen 40 million jobs lost. The emerging markets are becoming less attractive, which leads to continued capital outflow. A potential for sovereign debt crises becomes quite foreseeable.
Another sign of credit risk is the downgrade of credit ratings. According to Fitch Ratings, multiple ratings actions occurred across its portfolio of European, Middle East & African Emerging Market banks between 12th of March and the 30th of April. “Of the 100 bank IDRs reviewed, 86 were subject to negative rating actions. These included 16 downgrades, of which 15 were recorded in the Middle East and Africa, primarily in Oman, South Africa and Nigeria.”
The volatile fluctuations in the stock, bond and foreign exchange markets indicate that there is a high level of market risk in emerging countries. Up to May 15th, the MSCI Emerging Market index has dropped nearly 20% since the beginning of 2020, with the biggest drawdown of over 33%.
The recession forced central banks to apply expansionary monetary policy and lower the interest rate, which affects the bond prices as well as currencies. As mentioned before, capital is taking flight and withdrawing from the emerging markets, which would result in the currency depreciation.
For instance, the Turkish LIRA to the USD has decreased by over 16% since the beginning of 2020. Emerging market foreign exchange rates have been hit hard by the global market sell-off on the back of the coronavirus pandemic. Therefore, foreign exchange risk also remains at a heightened level. With expansionary economics, emerging countries must fix another key problem, inflation, which might become a serious problem and adversely affect people's daily lives.
The coronavirus caused a great shock in the financial markets, which may accompany operational risk as well.
In March, the Crude Oil futures achieved its first negative value. At the other side of the pacific, Bank of China (BOC) raised an operational mistake due to this unprecedented issue. Yuanyou Bao or literally “crude oil treasure”, is a futures product created by Bank of China linked to the West Texas Intermediate (WTI) futures.
However, BOC did not follow its peers’ practice of completing the position transfer a week or 10 days before the last trading day of the front-month contracts but only completed it just before the last trading day. Investors are not well informed on the potential downside risks of investments in general, in this case BOC allegedly did not inform them either.
The mistake has resulted in 60,000 Chinese investors’ losing a total amount of 10 billion yuan ($1.4 billion). While the emerging markets do not have a well-developed financial system, their operational risks would be higher than developed countries.
The greatest impact that the coronavirus brought to the world is the movement towards de-globalization, which has simultaneously witnessed a material increase in liquidity risk.
Global trading liquidity becomes highly restricted. The travel between countries is also restricted and difficult to pursue, which leads to the barrier of international trading.
Then, with the capital outflow and social distancing in emerging markets, the available funding liquidity for business also gets crushed. Furthermore, travel restrictions may limit the access of first-hand information for foreign investors, and slow down the information liquidity. Therefore, the overall liquidity risk is up.
There are still many other risks in emerging markets due to the coronavirus such as business risk, strategic risk, reputation risk and so on.
However, the main reason for the greater potential risk in most emerging markets rather than developed markets is due to governments functioning ineffectively. They do not even have sufficient healthcare resources and the ability to guarantee the nation's safety. This would be a lesson for the world and investors should pay attention to all kinds of risks all the time.
Written by Junping Chen & Edited by Alexander Fleiss
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