At a time when the U.S. and Eurozone economies are gradually coming back from years of zombie-like conditions, Emerging Market economies are going from bad to worse with South America being particularly badly hit.
EM debt is 107% of GDP and rising and, if one adjusts for all lending taking place outside the banking system (so-called shadow banking), the real number is closer to 130%. In the decade between 2004 and 2014, total EM borrowing increased by no less than $3 trillion.
Almost all of the increase is due to a rise in corporate debt, and much of it has been borrowed in U.S. dollars as a result of the extraordinarily benign borrowing conditions in the United States since the outbreak of the global financial crisis. As the Fed has now embarked on a cycle of rate hikes, which is likely to drive the dollar to new heights, and because commodity prices tend to be very negatively correlated with the dollar, Niels Jensen, economist and CIO of investment consultancy Absolute Return Partners, expects the fall in commodity prices to continue well into 2016.
Despite EM economies still expected to grow the fastest in 2016 – with the International Monetary Fund GDP growth estimate being 4.5%, leading to global GDP growth of 3.6% - the risk to those numbers is almost entirely on the downside. “The combination of rising debt servicing costs and falling commodity prices is outright poisonous for the many EM companies that make a living out of exporting commodities to the rest of the world. If the U.S. dollar continues to appreciate (as we expect it to do) and commodity prices sink to new depths, the overall conditions for EM exporters can only deteriorate further,” argues Jensen.
Foreign investors in emerging market securities made net withdrawals for an unprecedented six consecutive months in the second half of 2015, resulting in the lowest annual level of portfolio flows since the height of the global financial crisis in 2008, according to estimates by the Institute of International Finance, an industry association.