Milestones : Emerging Markets May Face Deeper Pain



IMF: Expects heavy demand for funds.

In the most bearish research report on emerging markets seen by Global Finance since the credit crisis began, an RBC Capital research note published on January 15 claims that most major emerging markets are already in recession and that their predicament is about to get markedly worse. If the report’s dire predictions play out, the developing world is certain to share the deep economic pain of the United States and Europe well into 2009.

The research highlights contractions in industrial production in Asia, Eastern Europe, the Middle East, Africa and Latin America and predicts that growth will crumble in emerging markets. RBC expects capital outflows of $50 billion to $100 billion in 2009 from emerging markets compared to annual inflows of between $250 billion and $650 billion from 2004 to 2008. Those outflows will further exacerbate the crisis facing developing countries.

“Investors should brace for severe economic headwinds—much worse than already seen,” the research states. In 2008 the MSCI Emerging Markets Index fell 54%, its worst performance since it was launched in 1987.

RBC explains that emerging markets will be hit by sharp falls in exports as worldwide demand collapses. In addition, continued low commodity prices as global growth slows and the ongoing financial pain affecting countries worldwide will have particular resonance in emerging markets, where stress on banking systems, often less robust than those in the West, will take its toll.

The bank believes that, for a number of reasons, the economic collapse in emerging markets could be both more severe and longer lasting than the current consensus would suggest. First, access to credit and liquidity for most emerging market banks and corporates (and some sovereigns) remains restricted. That will impede emerging market countries’ ability to substitute domestic demand for weak external demand—long the hope of many optimistic observers of emerging markets.

Second, a re-rating of emerging market credit risk has not yet happened, and downgrades and defaults look set to pick up sharply (the report notes the IMF now believes it may need an additional $150 billion to provide assistance to crisis-hit emerging markets). And while many emerging markets have accumulated large export windfalls in recent years, these are finite. Spending them to try to get out of recession will eventually hit the fundamental outlook—and the credit ratings—of emerging market countries to a much greater extent than for developed markets facing the same problems.


Laurence Neville