IMF MD Christine Lagarde. Picture: REUTERS
IMF MD Christine Lagarde. Picture: REUTERS

It’s like being midway through a detective thriller: it’s clear there is something going on in emerging markets, but it’s not clear what. At least not yet.

Two things are apparent, however. First, as of last week emerging-market stock markets are officially in bear territory. Second, after two countries, Pakistan and Argentina, have thrown themselves to the mercy of the IMF, the organisation’s MD, Christine Lagarde, has warned of rough seas ahead for emerging markets. In a speech last week, Lagarde warned of “market corrections, share exchange rate movements and further weakening of capital flows”.

Yet even in its initial stages this particular crisis is unusual. Even the title “emerging-market crisis” is something of a misnomer since many countries normally tagged in this category are very far from being in a crisis situation. The issue for investors is trying to work out which countries are vulnerable and which not.

That depends a lot on the extent and denomination of the country’s debt. The three countries that have been hit hardest up until now, Argentina, Turkey and Pakistan, all have very high levels of US dollar-denominated debt. And that provides a clue as to the root cause of the problem; rising US interest rates and a stronger dollar have changed the global investment context profoundly.

Since the start of 2017, the US has been on a gradual process of increasing interest rates, starting at 0.5% and reaching 2.5% in September after another 25-basis-point hike. It has been a thoroughly publicised and careful process, but that does not change the fundamental fact: the era of free or almost free money in the developed world is coming to an end.

This has posed a challenge to countries around the world. How would they, or should they, respond? The answer has been mixed. Some have tried to raise interest rates alongside the US increases, in the hope of maintaining capital inflows. Others have stood pat, including, more or less, SA. Others have actually dropped rates. 

Three key economies provide the best example: China’s rates have been flat at 4.75% for an extraordinary period of three years. Brazil’s interest rates have come down at a dizzying pace, from 14% to 5.5% over the past two years. Indonesian interest rates were held firm for a while, but now are on a fast upward trend, moving from 4.5% to 5.75% over the past year.

Some of the difference can be accounted for by changes in currency valuations. The decline in the value of the rand and the Brazilian real, for example, have helped improve prospects for exporters and improved the trade balance. Like many other emerging-market countries, they have taken the hit on the currency, which has obviated the need to be aggressive with interest rates.

Some of the difference can also be accounted for by big changes within emerging-market countries over the past decade. The Wall Street Journal reports that emerging economies’ reliance on foreign money has diminished compared with a decade ago. In 2017, overseas capital flows to emerging markets equated to 4.35% of GDP compared with almost 9% in 2007, according to the Institute of International Finance.

The crisis is much more focused this time. According to one bank, Turkey, Argentina and Venezuela account for 35% of the widening gap between emerging-market bond yields and US treasuries.

Yet it would be naïve to believe that something is not amiss. The tech sector across the world has taken a thumping hit, a suggestion that optimism is waning. One of the most crucial changes is that Chinese growth, the motor of emerging-market performance, has slowed, taking some of the wind out of the sails of the category. For African markets, this is of particular concern because of the effect on commodity prices, and they too have been generally in a holding pattern for the past two years.

What is unfolding now may not be best described as an “emerging-market” crisis; the title is too blunt an instrument to describe the increasingly different countries in the category. It may be that the extent of debt and its denomination will be the crucial differentiator. For SA, with most of its debt in local hands but with lots of it, that is both good news and bad. But one thing is sure, expect choppier waters.