Thursday, 28 January 2016

Divergence in Monetary Policy and Macro-Risks for Emerging Markets

Are we entering a great divergence between the developed world and Emerging Markets, particularly for oil-fuelled economies and currencies?
In the UK the pound has taken has fallen off its perch by 6% against the dollar in the last few weeks alone - is it the spillover from the travails of the markets or in part a response to increasing country risk amidst a rise in chatter of Brexit?I was contra-market in my projections for UK base rates for 2016 and with the continued - possibly sustained - low oil prices, the arithmetic for inflation has changed and in turn the likelihood of tighter monetary stances.
Whilst the Fed's rate rise of 25 basis points was expected and arguably sound given its inflation target of 2% the landscape in the Euroland remains positively soporific. Again, more recent data shows that a lower inflationary perspective whilst Super Mario has in recent days sought to allay fears of an end to QE.
There is a deeper question for another day whether central banks role of de facto lenders-of-last-resort is now the norm and whether markets are addicted. Or what further can policy-makers more generally do in terms of firepower and tools, at least in the developed world, given near zero (or in some instances negative) interest rates and at least in the EU self-imposed strait jacket of fiscal restraint.
And the risk that the debt overhang that began in 2007 and mutated into various forms, has yet to play out.
And the Divergence?
In part this great Divergence is - like many of the economic-cum-financial narratives of the last decade - being affected and driven by developments in the middle Kingdom. China.
Anyone with experience in transition countries and a grounding in National Accounts will tell you how data can be massaged. I suspect that real activity is probably 40%-60% of what is being officially reported. And this in turn is affecting demand for commodities and hydrocarbons despite official orders to maintain production (and more importantly politically - employment) targets although the Chinese are making fantastic efforts at Energy Efficiency and switching away from hydrocarbons.
Three Major Implications I see:
  1. In the last couple of weeks we have seen a queue of oil producers, from the big cheese of them all Saudi Arabia, through to Russia, Azerbaijan, Nigeria through to Equador and even Venezuela facing huge macro-instability on the back of falling oil revenues that fuel both external and internal accounts. Saudi is talking of fiscal reforms to cut subsidies and even privatising part of ARAMCO, its oil genie. Azerbaijan is talking to the IMF for a possible support. Whilst most of these countries have followed sweet-talking consultants and set up whizzy wealth funds, these and the FX reserves will quickly deplete if authorities try to beat the markets (Soros or no). So expect tighter monetary policy, falling currencies and higher imported inflation in EM space - particularly for commodity-based economies, but with spillovers to neighbouring satellite economies (Russia and CIS par example).
  2. Debt Overhangs in EM. Deja vu 1990s? EM FX loans, particularly dollar-based will mean currency mismatches, although Russia's corporate sector is largely immune following the financial sanctions (although it's still in a macro-mess that will impede Mr Putin's foreign policy aims).
  3. Low Income countries haven't really had a mention but those of us who have worked across investment and risk analysis and development will be aware of the potential risk to vulnerable economies and the potential counter-cyclical hit it will have on public finances for economies most exposed. The EU successfully pushed through a package to aid 30 odd countries in 2008 in Africa and the Pacific by helping to ringfence critical public expenditure in health, education and public services - more of the same may well be required.

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