- To assess the macro risk climate, we rank macro vulnerabilities across 25 key EM economies
- Compared to some large emerging market economies, Asian countries look fairly healthy
- Taiwan and South Korea have some of the best scores in the EM space
- Thailand and Philippines have downshifted somewhat from strong external positions
- China, India, Malaysia, and Indonesia fall in the middle of the EM vulnerability cohort
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Commentary: Rising rates; EM vulnerability
As the US Federal Reserve gears up for interest rate normalization, field curves have shifted in anticipation. The short end of the curve has steepened, the USD has been strengthening, and equity market volatility has risen considerably. For emerging market economies, the environment for fund raising, at the private or sovereign levels, has become challenging. Additionally, high commodity prices will compound the outlook for energy import-dependent economies.
Hence the year that was supposed to be about re-opening after prolonged pandemic-induced stringent measures, is likely going to be a challenging one for a number of emerging economies with inadequate external buffers against substantial funding needs. But which are these economies within a large cohort?
Last week we published the results of a comprehensive macro risk assessment exercise across 25 key emerging market economies (link here). Economies scoring poorly in this exercise run risks of disorderly currency depreciation, capital flow volatility, debt service difficulties, and broader financial and economic distress
Key indicators of analysis are foreign exchange reserves, fiscal balance, private and public sector debt, external (hard currency) debt, savings-investment balance, gross external funding requirement, and real exchange rate (REER). With the exception of REER, the vulnerabilities are assessed in simple ordering. If country A’s debt if higher than country B’s debt, A scores poorer than B.
As for REER, the comparison is a little more complex. If a country’s real exchange rate is 30% above trend, is it more vulnerable than a country which is facing a 30% undervaluation relative to trend? Both are large misalignments, and both come with associated risks. In the former case, the risk could be economic overheating, excess and unhedged borrowing, and excess capital inflows. In the latter case, the risk would include high imported inflation, loss of purchasing power, and external debt service difficulties. We deal with this issue by taking the absolute deviation of REER from long-term trend; this allows us to catch risks at the both end of the spectrum.
We examine the evolution of these indicators across time series and cross section data, which allows us to glean shifts in relative vulnerability
Key findings:
- In general, vulnerability indicators have worsened in EM in recent years, as both the cover for foreign obligations and fiscal position have slipped in many countries;
- Compared to some large emerging market economies, Asian countries look fairly healthy;
- Taiwan and South Korea have some of the best scores in the EM space
- Thailand and Philippines have downshifted somewhat from strong external positions
- China, India, Malaysia, and Indonesia fall in the middle of the EM vulnerability cohort; while there are other economies with worse fundamentals, a year of higher rates and likely volatility in capital markets will keep the policy makers of these four economies on their toes.
We also run the exercise with the data available for each year, going back to 2016. We find:
- South Korea and Taiwan have consistently led EM rankings;
- India, Indonesia, Malaysia have not moved much;
- Driven largely by massive debt build-up, both private and public,, China has slipped from #9 in 2016 to #14 in 2021;
- The pandemic has been harsh on the Philippines Thailand, as the former slipped from #3 in 2016 to #8 in 2021, while the latter slipped from #2 to #11 during the same period.
Macro vulnerabilities don’t emerge overnight; they build up steadily. Keeping track of them therefore does not warrant monitoring of high frequency data. In this exercise, we find that a wide array annual data provides the depth and breadth necessary to carry out such analysis. We plan to keep extending this annual exercise.
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