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The Budding Threat to Developing Countries

20 OCTOBER, 2021
Macro Global Insights
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The astronomer Copernicus affirmed in the XVI century: "numerous are the disasters that generally provoke the decadence of kingdoms, principalities, and republics; the four most fearsome are: war, plagues, famine, and inflation.  Everyone warns of the first three, but very few warn of the fourth because it does not operate suddenly, but in a sneaky and continuous way, generating the fall of the States".


To date, we are concerned about the levels of inflation in the West.  Regardless of their seasonality, the situation generated by inflation in emerging countries is particularly worrying.  For example, inflation in Mexico stands at 6%, in Russia at 8%, and in Brazil at 10%.


Some time ago, I warned about the risks that were brewing in developing countries.  In my opinion, the situation has gotten worse:


First: many emerging countries are experiencing very dramatic public health situations associated with covid, either because of a lack of hospital resources (especially ICUs and ventilators) or because of the impossibility of applying strict confinement or very low vaccination rates (Figure 1).  As a consequence of this health situation, resentment in the economies is very intense.  This explains why, for the first time in decades, between 2020 and 2021, the GDP differential between OECD countries and emerging countries will widen, not narrow.



Second: inflation has also taken its toll in many developing countries.  The reasons for this are varied, but they generally coincide in the fact that the most inflationary items, such as energy or food, weigh much more heavily in the basket of an emerging consumer than in that of a Western one.  Energy is up nearly 20% so far this year.  Food is up 33% (at its highest level in ten years).  As a result of these price increases, many central banks (e.g. Russia, South Africa, Mexico) have had to raise interest rates, which will weigh down future growth.   Other countries exposed to huge levels of inflation, such as Turkey, which, depending on the statistics used, could be facing price increases of between 20% and 40%, have nevertheless opted to lower rates, following the president's economic theory, according to which the best way to deal with inflation is to lower rates, not to raise them.  As a result, the Turkish lira is at its lowest level against the dollar since World War II (Figure 2).



Third: if OECD countries have indulged in historic fiscal efforts (also only comparable to those of the Second World War) at abnormally low interest rates, this is only due to the massive support of monetary policy, as central banks have monetized much of the debt issued by countries (again, emulating what happened during the war).  However, many emerging countries have not been able to pursue this strategy with the same intensity, as they are not financed in their own currency, but are partially financed in dollars.  This means that if fiscal and/or monetary policy is abused, the emerging currency depreciates against the dollar, which makes the emerging country's cost of financing more expensive.  If the emerging country in question also has a current account deficit, its vulnerability increases as it depends on foreign savings for financing.


Fourth: many developing countries enjoyed an economic bonanza during the last decade, associated with lower financing costs, the arrival of investment flows, and high commodity prices.  Instead of taking advantage of this boom period to avoid imbalances in the form of excessive increases in public and private debt, the opposite has generally been the case.  Emerging public and private debt levels are at record highs.  In more than one country, the hefty increase in private debt has generated real estate bubbles, leaving its financial sector vulnerable.  These are the harbingers of future crises.


Fifth: high levels of debt sometimes have heavy maturities in 2022 and 2023.    If we take into account that: i) part of these maturities will have to be paid in dollars, ii) many emerging currencies have fallen sharply against the dollar, and iii) the economic situation is extremely fragile, it is possible that we will see episodes of debt restructuring (IMF interventions) or bankruptcies in the coming years.


Sixth: most emerging countries (with exceptions such as Turkey) benefit from high commodity prices.  If the Chinese real estate market is experiencing a change of cycle (over three developers have already defaulted) and China shifts to building a much more sustainable number of homes, this will translate into lower demand for commodities, which in turn will lead to lower prices, making it very difficult for many emerging countries to obtain dollars, crucial to refinance their debt stock.


Copernicus pointed out four evils that beset nations.  Unfortunately, inflation does not act alone today.  Many emerging countries are also plagued by plague and famine (and we shall see in the future whether war will strike). 


Be it selfish and/or altruistic, Western countries should provide aid.

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