This could be the biggest emerging market crisis ever

How will international finance debt obligations impact emerging and frontier economies during the Coronavirus pandemic? Elias Papaioannou, Professor of Economics at London Business School and Academic Director of the Wheeler Institute for Business and Development was joined in conversation with Sebnem Kalemli-Ozcan, Professor of Economics at the University of Maryland, Research Associate at the National Bureau of Economic Research (NBER) and a Research Fellow at the Center for Economic Policy Research (CEPR) to discuss how the situation in emerging markets is such a cause for concern. 

  • The combination of a health crisis, capital flow reversal, a demand and supply shock and exchange rate crisis has created severe implications for emerging markets;  
  • The risk sensitivity of capital flows in and out of emerging markets compounds the impact of COVID-19; as does whether the external debt is held by official lenders or private institutions; 
  • Borrowing obligations in emerging markets are not limited to governments, but also large firms holding private debt, increasing the complexity of organising a collective response and increasing the risk if several get into difficulty; 
  • International financial institutions are going to have to support emerging economies because they are integrated into the global financial system;  
  • A global response will be required to support firms of all sizes across different markets, with institutions having to be prepared to support enterprises of all sizes. 

A perfect storm of shocks has emerged, with emerging and frontier economies taking a severe hit, and the shockwaves being felt throughout the global financial system 

During her discussion with Elias Papaioannou of London Business School’s Wheeler Institute, Sebnem Kalemi-Ozcan set out why the coronavirus is such a significant issue for the banking systems in emerging economies.  

Capital flows in and out of emerging markets are very risk-sensitive, as Kalemli-Ozcan presented to leading central bankers last year about US monetary policy, international risk spill overs, and policy options. She stressed the importance of risk perceptions of foreign investors for emerging market capital flows and the impact of US monetary policy on those risk perceptions. The country-specific effect is determined by their existing risk profile, so investors will exit from counties they perceive to be riskier first, even though the macroeconomic fundamentals of that economy are strong. The risk is associated with institutions and governance, which is going to play a tremendous role in emerging markets.  

Kalemi-Ozcan thinks there will have to be different approaches based on a country’s situation. Most of the bad debt in low-income countries is with official lenders, which can be coordinated and a freeze could be negotiated. For more developed frontier economies, on the other hand, external financing has shifted to private lenders, which makes it more difficult to freeze payments and renegotiate debt terms on a wider basis. The scale of external debt obligations is significant, which when combined with capital leaving the market and the domestic pandemic response, an incredible amount of fiscal resources are required. Additionally, private sector firms are also borrowing in foreign currencies from private sources. With rapid exchange rate depreciation, if firms default and the government has to step in as the vendor of last resort, these foreign currency obligations are going to cause significant complications across the economy. Small firms also add to this situation, as they borrow through domestic banks, so if there are widespread defaults on these loans, the banks cannot pay back foreign lenders, leading to difficulties from both the corporate sector and the banking sector for the government. The Financial Times has also written about how currency falls and reduced foreign revenues will leave emerging economies scrambling to avoid default.  

Global action and coordination is going to be critical because of the intertwined nature of the international financial system 

Looking at Turkey as a representative large emerging, frontier market, with an open economy that has international borrowing commitments both from the government and corporates, Kalemi-Ozcan thinks external debt that needs to be rolled over this year externally could be as much as 23% of GDP. At the same time, the country also needs to find fiscal space for resources relating to fighting the pandemic; currently, they have only pledged around 1% of GDP compared to 35% in Germany and 10/15% in the UK and US. According to Kalemi-Ozcan, this is not going to be enough, so all policies need to be on the table, where more domestic and external funding will be required, including ‘taboo’ policies such as monetary financing. International financial institutions will need to support emerging economies such as Turkey because they are integrated into the global financial system. This will ratchet up the risk for the global financial system, which Kalemi-Ozcan calls the ‘spillback effect’, because if lenders are major global banks then there will be severe implications for global economic stability if banks in the emerging economies in difficulty.   

The conditionality that accompanies help from global institutions might sometimes be difficult. However, it is vital that small- and medium-sized enterprises that make up the backbone of the economy survive. The liquidity issue caused by the pandemic, which has brought about a demand side, supply side, financial side and external capital side shock, will lead these businesses to bankruptcy, even if the underlying business was sustainable. The global nature of this challenge means everyone needs to come together, across the scientific community, political community, international institutions, to ensure resilient businesses get the support they need, regardless of where they are located. No country or business can prevail through this crisis alone. Kalemi-Ozcan has calculated that covering the payroll of all small businesses in the US for three months with conditional employment, i.e. not firing anyone, equates to around 3.5% of GDP; for businesses in Europe and Turkey, it will be less. Accordingly, emerging economies need to find these fiscal packages to protect their small firms and SMEs, therefore global policy will have to be in place to help them.  


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Elias Papaioannou’s conversation with Sebnem Kalemli-Ozcan is part of the Wheeler Institute’s COVID-19 series – bringing together the expertise and experience of our extended community to understand, illuminate and offer solutions to the challenges created by COVID-19. Our differentiating factor is the role of business in addressing these challenges, with a focus on the implications and actions for those in developing countries.   

If you’re interested in following the Wheeler Institute COVID-19 series, check out our last episode, The Coronavirus pandemic will be an opportunity to make the South African economy more fair and reduce inequalities’ with Nick Binedell.

Elias Papaioannou is academic director of the Wheeler Institute for Business and Development and professor of economics at London Business School, focusing on international finance, political economy, applied econometrics and growth and development. 

Sebnem Kalemli-Ozcan is Neil Moskowitz Professor of Economics at the University of Maryland. She is a Research Associate at the National Bureau of Economic Research (NBER) and a Research Fellow at the Center for Economic Policy Research (CEPR). 

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