Financial markets are being rocked by an unprecedented crisis as a coronavirus is spreading around the globe. In February, most sell-side analysts were still assuming that the virus would be a short-term supply shock, mostly centered on China, and that a V-shaped recovery would present itself somewhere in the 2nd quarter of 2020, pointing to rapid reversal of economic conditions following the SARS epidemic in 2003 as evidence. This now looks misguided if only because China has become a dominant economic powerhouse since then, representing 17% of global GDP. China’s share of global trade in 2003 was equal to 5.3% but increased to 12.8% last year; in 2003, its economy churned out cheap t-shirts and sneakers whereas today it is a global leader in manufacturing electronics and medical supplies, amongst others.
China’s stringent lockdown measures (China’s leaders are experts in locking up people) notwithstanding, the virus now is a global phenomenon with the epicenter gravitating to Europe and moving towards the U.S. A few weeks ago, China’s actions were deemed unthinkable in Europe. But now many countries belatedly are following China’s policies, closing restaurants, cinemas and sport stadiums and only allowing essential services to remain open (which in Amsterdam includes coffeeshops, apparently). Governments in Emerging Markets have responded differently to the crisis. Korea and Singapore acted early and appropriately by testing many people and isolating infected cases, thereby limiting their spread. Argentina, having close links to Italy, realized that a lockdown would be required to avoid stress on its hospitals whilst Brazil’s president, Jair Bolsonaro, was still high-fiving with his fans outside the Palacio do Planalto, even though two of his own ministers tested positive for the virus. India, the country that maybe is least prepared for a pandemic, imposed travel restrictions and a curfew but still could see a significant outbreak in the days ahead, a frightening prospect given its high population density, endemic poverty and overburdened public health system. Ex-pats are leaving the country in droves.
The economic consequences of the pandemic for Emerging Markets are highly uncertain as we are in uncharted waters. China’s lockdown resulted in a fall of industrial output of 13.5% in the first two months compared to a year ago. Retail sales were down 20%. Oil prices cratered after a belligerent (and ignorant) Saudi prince started a price war after Russia’s refusal to cut production in an OPEC+ meeting. With Brent trading well below US$ 30 per barrel, this obviously is bad news for oil producers, including Saudi Arabia itself. Tourism, an important source of income for countries like Mexico and Thailand, obviously, will suffer whilst demand for copper and other metals plunged as construction companies and carmakers reduce capacity. We do not pretend to know what the impact of this pandemic on the economy will be but that we are facing a global recession seems a foregone conclusion. Until a vaccine is available for mass-application, we are likely to undergo rolling lockdowns for some months until infected cases are completely isolated. 2020 seems to be a lost year, economically speaking.
Putin for life, Brent below US$ 30, Coronavirus everywhere, global recession… what a year!
Emerging Markets are entering this recession in worse shape than during the global financial crisis of 2008. Then, economies had veered back to health thanks to buoyant commodity markets and years of frugality. Average public debt in 2008 was only 34% of GDP against 55% presently. The larger EM countries have been able to issue debt in local currency, making them less vulnerable. However, a significant share of local debt is held by non-residents, in Malaysia, for example, more than 40% (Indonesia, Peru and South Africa are also highly dependent on foreign investors). Current accounts generally seem in better shape but this partly is due to lack of growth (think of Brazil or Mexico). FDI flows surely will dry up as large companies dial back capex plans, especially in oil & gas and mining. Thus, credit metrics will further deteriorate, also due to strengthening of the dollar. However, most of these larger economies will be able weather the storm (though some need outside help). Smaller EM countries (also known as frontier markets) are in a worse position, as they only have been able to issue in dollars and also already have relatively high debt levels (often even more so than the larger economies). Argentina and Lebanon didn’t need a pandemic to default on their debt. We are afraid some more will follow, despite an US$ 50 billion pledge by the IMF to support these countries in the difficult times ahead. Moreover, corporate debt levels nowadays are stratospheric, aggravated by currency depreciation and greatly reduced profits as a result of the economic slowdown. In 3Q19, non-financial corporate debt equaled 94% of GDP, according to the IIF and a lot of this debt is denominated in US$. Some debt is quasi-sovereign, like Eskom and Pemex, and may require substantial support from the sovereign going forward.
Coronaviruses are very common and fortunately most are not very lethal (although some can become so later-on after complex permutations). However, the risk of a pandemic now is higher than in the past due to increased ecological disturbances like, for example, mining in remote areas (the Amazon, Borneo), globetrotting by the masses and rapid urbanization. Better preparedness of pandemic events in the future seems sound policy. Many governments in the West will reflect on the events and conclude that reliance on offshore manufacturing for essential supplies may not be in their interest. This discourse already came to the fore in relation to 5G telecoms equipment and associated security issues but it is likely that many countries will take this forward and also will look at onshoring production of generic drugs and other medical supplies. Global trade may decline permanently. Not an optimistic message for Emerging Markets…