AlwaysFree: World’s Riskiest Markets Stumble Into Crisis With Dollars Scarce

• Vulnerable economies suffer hard-currency shortages, debt risk
• Wall Street opts for a cautious approach in developing assets

According to Bloomberg article published on March 5, 2023, hospitals delaying surgery in Sri Lanka. International flights suspended in Nigeria. Car factories shuttered in Pakistan.

In some of the world’s most vulnerable developing nations, the situations on the ground are dire. Shortages of dollars are crimping access to everything from raw materials to medicine. Meanwhile governments are struggling with their debts as they chase rescue packages from the International Monetary Fund.

It’s forcing a rethink of the bullish emerging-market consensus that swept Wall Street just a few months ago. Granted, few expected the challenges facing certain frontier economies to be remedied this year, but pain has deepened alongside a rebound in the greenback.

While trouble at the fringes of the developing world is unlikely to drag down the asset class as a whole, some say it will force money managers to be increasingly tactical in their investment allocations in the months to come.

“There’s a real crisis brewing in these troubled nations and for some, things can still get even worse,“ said Hasnain Malik, an emerging and frontier-market strategist at Tellimer in Dubai. “Investors will need to be even more vigilant in screening for vulnerability and differentiating country risk to avoid being surprised by the next Ghana or Sri Lanka.”

In Pakistan, factories have halted operations in the past months as they ran out of hard currency to import raw materials. In Sri Lanka, the government is setting a limit of 20 liters of fuel per person a week and government hospitals are postponing non-urgent surgeries due to the shortage of drugs and other medical supplies.

That’s not to mention the international carriers that suspended flights to Nigeria due to the difficulty in repatriating dollars from the nation. In Bangladesh, power producers are seeking $1 billion of foreign currency from the central bank for fuel imports to avert a looming energy crisis. Malawi, too, is facing a shortage of pharmaceuticals, fertilizer and diesel amid declining imports due to the dollar crunch.

JPMorgan Chase & Co.’s Next Generation Markets Index, which tracks the dollar debt of what it calls pre-emerging countries, posted a 0.4% drop last month, the biggest since September. And amid the dollar’s recent vigor, currencies from Ghana, Egypt, Pakistan and Zambia have crumbled far more this year than their global peers.

That has some money managers embracing more careful approaches, a break from the broad emerging-market optimism seen at the beginning of the year.

“These countries are mired in economic collapse, and some like Pakistan are teetering on the edge of another default,” said John Marrett, senior analyst at the Economist Intelligence Unit in Hong Kong. “Major parts of their economies are struggling. The currencies are worth far less too.”

More risk-averse money managers, meanwhile, are instead hunting for attractive yields in debt from governments that have managed to keep their fiscal deficits in check and currencies relatively stable. Barclays Plc has pointed to Mexico and Colombia as nations heading toward further fiscal consolidation.

Dangerous Cycle

For nations such as Sri Lanka, the trouble began years ago as officials spent valuable hard-currency reserves to keep local exchange rates artificially high. 

But it was Russia’s war in Ukraine and the Federal Reserve’s aggressive policy tightening, which drove the dollar to generational highs. That pushed many frontier economies closer to the edge as soaring energy and food prices drained their coffers.

“It’s tempting to say there’s an EM crisis because of the Fed tightening, but that takes the human agency away from policymakers in select countries that were enacting unsustainable fiscal policies,” said Samy Muaddi, head of emerging-markets fixed income at T. Rowe Price in Baltimore. “That said, tighter financial conditions are now exposing policies in some of these countries that are proving unsustainable.”

About two dozen nations are lining up for aid from the International Monetary Fund, though progress has been slow for nations hobbled by debt negotiations. The year has already seen several debt-laden countries — including Egypt, Pakistan and Lebanon — drop their exchange rates as they attempt to unlock rescue funding, with currency traders bracing for a potential wave of devaluations.

For Brendan McKenna, an emerging-market economist and strategist at Wells Fargo Securities LLC in New York, those who are willing to take the risk can find opportunity in countries with a clear reform agenda and a path toward support from official lenders, such as the IMF. 

“Pakistan, Sri Lanka and Ghana — maybe now is not the time to deploy capital there,” he said. “But Egypt could be an opportunity if the IMF program is successful at supporting the economy while tough reforms are implemented.”

What to Watch

• China will be in focus as the National People’s Congress, slated to open on March 5, will set the economic and social agenda for the coming year. The nation will also release data on exports, consumer price inflation and factory-gate prices in the coming week.
• Traders will monitor inflation figures from the Philippines, Thailand, Russia, Mexico and Chile.
• Poland’s central bank is likely to keep the key interest rate at 6.75% as the nation’s tightening cycle ends. Bloomberg Economics expects the next move will be a rate cut, potentially in the second half of 2023.
• Bank Negara Malaysia will probably keep its benchmark rate on hold.
• Peruvian policymakers will meet Thursday to decide their key rate.
• Brazilian IPCA data for February will probably shed light on the pace of disinflation, according to Bloomberg Economics

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