The Consequences of the Global Liquidity Crisis for Emerging Markets Investors
The short – but extremely eventful – history of the COVID-19 crisis began in emerging markets (EM). As the crisis expanded to encompass the globe, it has morphed from an exogenous shock affecting mostly EM, to an oil shock impacting risk assets including EM, to its current manifestation: a liquidity shock to global markets, resulting in substantial outflows and plunging prices in EM. Asian currencies and Asian equity and debt markets have collapsed,1 culminating in the closure of financial markets in the Philippines on March 17.
It will be some time before EM investors are able to align their decision making to fundamentals2. At this point, liquidity is the key factor to watch. To that end, this commentary will focus on the impact of the current liquidity shock on EM debt and equity markets.
Dependence on Liquidity and Flows
EM markets have seen a regime shift to what seem like end-of-cycle conditions in which liquidity, positioning, funding needs and fears of forced selling are front and center. Fund flows are an immediate area of focus. Many EM economies are running large current account deficits (see Figure 1) that they have compensated for through flows in capital accounts and foreign direct investment (FDI). FDI has been stable or declining in most EM countries, although lower oil prices have supported EM trade balances overall. Based on current account balances and FDI, South Africa, Chile, Colombia, and Indonesia are most in need of flows (see Figure 2).
Of course, the present inertia does not mean that emerging markets are free of fundamental challenges. Emerging markets’ potential for GDP and earnings growth are a serious concern. In addition, much-needed structural reforms are likely to be put on hold as EM countries focus their attention on combatting the outbreak.