How the emerging market turmoil could set the basis for the next recession

The emerging market crisis could spark financial contagion and slow down the global economy, contributing to an expected downturn in the next years.

Kai Zuberbühler
Sep 8, 2018 · 2 min read

Ten years after Lehman Brothers, developed markets are at at new highs, the global economy is booming — all thanks to low interest rate policies.

But in the emerging markets, there’s another situation. Interest in emerging markets was sluggish. The quantitive easing policy in the West just contributed too much to market performance there, reshifting focus away from the before well-performing emerging markets.

Financial institutions haven’t been a fan of the low interest rates since their introduction during the financial crisis. Banks had to rethink their strategy — shifting it to the debt market in emerging markets.

Companies there, however, face massive problems to repay their debt. With the risk of rising debt when the local currency drops, people try to hedge the risks — betting on a dropping local currency or shifting their assets into foreign currency. This all makes the fear of dropping EM currencies reality.

The Fragile Five

Some EM economies are extremely dependent on debt in foreign currency. In 2013, Morgan Stanley brought up the term ‘the fragile five’ — five economies with extreme dependency on foreign debt.

But which five economies have the dishonor to be on this list is disputed. Currently often named are Colombia, Indonesia, Mexico, South Africa, Turkey, Argentina, Pakistan, Egypt, and Qatar.

South Africa just slipped into a recession. Turkey is has high inflation and is in fear of a debt crisis — and even worse, under rule of a leader named Erdogan. Argentina is experiencing high inflation as well, and additionally, weak GDP growth.

In turmoil

European banks are already taking hits, as well as the Euro currency itself. Investors are fleeing to safe heaven currencies, such as the Dollar, the Yen, or the Franc.

The MSCI Emerging Markets Index is now down more than 20 percent since its recent peak. Now, officially, emerging markets are in a bear market.

With a more and more interconnected financial system, contagion will happen. The question is not if but how much developed markets will be effected.

The turmoil in these countries might not be enough to start a global economic downturn, but it makes one more likely and heftier.

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