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Emerging markets: potential upside from COVID-19?


The impact of COVID-19 has aggravated pre-existing challenges for Emerging Markets (EM). That said, in the long-term, it could also enable those EM economies to respond effectively to create better conditions for the future.

At the moment, EM authorities face critical policy decisions as certain growth-dampening secular trends that were under way before the COVID-19 crisis are now set to accelerate. These global trends might be unstoppable, but the speed and quality of EM responses will be critical in shaping the medium-term trajectory.

EM face the point at which the costs of economic lockdown potentially outweigh the benefits of flattening the COVID-19 curve more rapidly than advanced economies. As a result, it is possible that EM countries could reopen their economies relatively swiftly. While this approach may be risky, it could put EM countries in a relatively strong economic growth position if done right.

In the early phases of the crisis, the combination of a global economic recession and an unexpected global pandemic wrong-footed EM. Some early proposals to ease the liquidity crunch made matters worse but soon after, liquidity improved because of rapid multilateral support, short-term official bilateral debt relief, enhanced dollar availability and policy responses.

Now markets are seeing high-yielding sovereign-debt issuers returning to international capital markets. However, short-term risks remain as EM economies emerge from lockdown.

In response to COVID-19, the International Monetary Fund (IMF) provided more support for EM sovereign debtors by granting numerous financing programmes. The G20 bilateral debt relief agreement gives eligible low-income countries an additional short lifeline.

But the G20’s appeal to private creditors to provide comparable relief has somewhat scared investors. Not only are there legal and practical intricacies, but there’s also the risk of unintended consequences. From the debtors’ perspective, those consequences could include credit-rating downgrades and loss of market access. In fact, as of late May, only about 30 per cent of the countries eligible for official bilateral debt payment, requested it.

That said, outright multilateral support and official bilateral debt relief seem to be the best solutions. They enable rapid liquidity relief, uniform accountability criteria and protection against moral hazard. With these foundations in place, private creditors should be keen to participate in providing liquidity to EM countries through new bond issuances.

On another positive note, EM central banks have been lowering policy rates in the face of currency weakness. This decision is seen as sensible for several reasons: the projected record contraction in economic growth; strong disinflationary forces; and monetary policy space exceeding fiscal policy space in many countries. There is also more room for EM central banks to manoeuvre because developed market central banks have cut interest rates aggressively.

In addition to, a growing number of EM central banks are also entering unfamiliar territory by buying government bonds. The possible motivations stemming from this seem to be to finance growing budget deficits and to temporarily ease bond market dislocations caused by uncontrolled portfolio outflows.

Certainly, COVID-19 has created atypical challenges for EM economies, and the quality of their policy responses might be even more important than before. Any wrong move from policymakers could possibly exacerbate credit quality and asset prices.

Undoubtedly, EM countries that use the crisis to better build their economy could take a turn for the better, while those that use the crisis as cover to free-ride on debt relief measures or pursue risky unconventional policies are more likely to relapse. In conclusion, it is too early to quantify COVID-19’s full economic impact on EM but policy responses are crucial in times such as these and ultimately could highlight the winners and the losers.

Disclaimer: This article was issued by Maria Fenech, credit analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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