Governments around the world, faced with a wartime-like challenge in the form of COVID-19, are being forced to make a difficult choice: lock down their populations in an effort to contain the spread of the virus and suffer the economic consequences, or relax social distancing restrictions to ease the toll taken on their economies, but risk escalating infections and deaths.
The choice in the developed world has not been so dire: wealthy countries have the luxury of offsetting the economic impact of social distancing with both fiscal and monetary stimulus to bridge the chasm. Between the Federal Reserve’s quantitative easing and Congress’s $2-plus trillion CARES Act, US monetary and fiscal stimulus to date has amounted to nearly one quarter of GDP. The world’s wealthiest countries have chipped in monetary and fiscal stimulus equivalent to more than 13 per cent of their collective GDPs, according to Cornerstone Macro. Other studies have shown that in the long run, health and well-being trumps the near-term economic blowback when the value of lives saved and their aggregate contribution to future economic growth are fully considered.
The near-term economic ramifications for poor countries, by contrast, remain daunting. Analysts estimate the economic toll borne across the emerging world will be more severe than that of the global financial crisis of 2008. The total economic output of the world’s emerging markets is forecast to fall 1.5 per cent this year, representing its first full-year decline on record. But emerging market (EM) balance sheets aren’t strong enough to cushion the blow with offsetting fiscal spending measures. Poorer countries simply don’t have the tools to combat the impact of lockdowns, export demand destruction and the crude oil tailspin. Countries across Africa, Latin America and parts of Asia will be challenged to keep their economies afloat while keeping COVID-19 infections at bay:
- Governments on the African continent spend a mere $12 per capita on health care annually, compared to $4,000 per capita among developed countries with national healthcare programs and $9,500 in the United States.
- Oil-exporting countries in Africa and Latin America have suffered a stunning plunge in crude oil revenues, thanks to an escalating price war between Saudi Arabia and Russia. Latin America could suffer its worst economic contraction in modern history, exceeding the debt crisis of the 1980s.
- India could suffer a 10 per cent decline in Q2/20 GDP if 60 per cent of the country’s 1.4 billion peoples remain locked down through April. The government’s fiscal response has so far amounted to 0.8 per cent of GDP, which suggests that India would grow at a scant 1 per cent this year, its worst showing since the 1980s.
- Growth in China is likely to fall to its lowest level in a generation.
Though the economic impact of COVID-19 is severe for the emerging markets, their prospects, in nominal terms, are much better than what is forecast for their developed market brethren. The US economy is projected to contract nearly 30 per cent on an annualized basis in Q2/20. EM economies are less diversified than their developed market counterparts and many are reliant on commodities, tourism and remittances from citizens working abroad. But we note that EMs are no strangers to economic and political crises, with many having battled currency contagions in the past. Recent experience suggests many EM countries, unlike most of those in the developed world, are better equipped to navigate acute economic challenges. Additionally, many of these obstacles are factored into EM valuations. Emerging equity markets are currently trading at a price-to-sales ratio of one – that’s nearly half the valuation of the S&P 500, which is trading at 1.9x sales.
Emerging market countries don’t have the monetary muscle to prime the pump without stoking fears of inflation or a currency crisis. Emerging market equities have fallen 20 per cent in the last six weeks, wiping out gains logged since 2017, as investors have withdrawn a record $82 billion from EM, according to The Wall Street Journal. This has contributed to the more than 10 per cent plunge in EM currencies since February. The Mexican peso, the Russian ruble and the South African rand have each tumbled about 20 per cent in recent weeks. Adding insult to injury, Moody’s downgraded South Africa’s credit rating to “junk” last week.
Economic resiliency will be an important determinant of which emerging market countries struggle or thrive. One-third of Mexico’s economy relies on exports to the United States. China’s growing middle class is expected to be a much-needed source of domestic demand. Foreign exchange reserves, particularly gauged against external financing requirements, represents another ballast. Countries like Russia, India and China are well positioned in this regard.
The International Monetary Fund (IMF) has historically been the lender of last resort to the emerging world. According to its website, the IMF’s primary purpose is to ensure the stability of the international monetary system – the network of exchange rates and international payments that enables countries (and their citizens) to transact with each other. IMF Managing Director Kristalina Georgieva estimates that emerging countries could need as much as $2.5 trillion in support to combat the economic fallout of COVID-19. To date, the IMF has made $50 billion available and demand for the funding, not surprisingly, has been enormous. Mexican senator Mario Delgado is imploring developed countries to forgive Mexico’s foreign debt as well as the debt of other developing nations.
Of course, global economic outcomes will be determined in large part by the amplitude and duration of COVID-19 infections. Most models are predicting peak US hospitalizations somewhere between the end of April and the beginning of May. Countries that begin to relax social distancing restrictions would still require additional defensive measures, like testing, tracking contacts and protecting the vulnerable. A recent study led by Federal Reserve economists looking at the city-by-city effects of the 1918-19 flu epidemic found that those cities with the most stringent restrictions to stem the flu’s spread enjoyed the best subsequent economic performance.
As emerging market investors, we remain vigilant in monitoring ongoing developments with the pandemic, its impact on local economies and the response of local and global policymakers. We’re witnessing a divergence in equity market performance among emerging countries as investors assess the winners and losers. This suggests a shift in EM investments away from passive, index funds and into actively managed solutions, giving managers the flexibility to avoid risks while seeking prudent opportunities. Cresset believes an investment strategy focused around countries with high foreign exchange reserves and smaller reliance on foreign financing, combined with robust domestic demand, will prove to be a pragmatic strategy for navigating emerging markets through this difficult time. Please do not hesitate to reach out to us if we can be of assistance.