The rising cost of US dollar funding, escalating US-China trade tensions and China"s slowing economy will continue to generate a challenging environment for emerging markets (EM) over the next 18 months.
Tighter monetary and credit conditions are weighing on EM growth prospects, and Fitch expects Emerging Asian economies to be affected by further volatility in financial markets, which will test their resilience to external pressures. However, relatively strong fiscal and external buffers, as well as flexible policy frameworks, should limit the impact on sovereign credit profiles, says Fitch Ratings.
These conclusions were broadly shared by attendees at Fitch’s Global Sovereign Conferences held last month in New York, Hong Kong, and Singapore. Not surprisingly, however, Fitch surveys showed that concerns over EM turmoil and the slowdown in China were higher for investors closer to countries hit by volatility.
For example, 61% of attendees in Hong Kong and 45% in Singapore believed stress in emerging markets will get worse, compared with only 30% in New York. The majority of attendees in Asia also saw US trade policy, rather than global monetary tightening, as the biggest medium-term threat to the global economy, while the reverse was true in New York. Fitch has already downgraded global growth forecasts in response to the latest round of US tariffs on Chinese goods.
Fitch forecasts that the Fed will raise its policy rate four more times by end-2019 points towards further US dollar appreciation, weak capital flows to EMs, and a risk of further bouts of EM volatility.
Meanwhile, the rising cost of funding in US dollars is likely to continue to create pressures for borrowers in global credit markets, with the impact on EM financing conditions exacerbated by the sharp rise in foreign-currency-denominated debt over the past decade, the vast majority of which is denominated in US dollars.
Non-bank foreign-currency debt has risen by around 180% in emerging markets since end-2006. The increase was slower, but still rapid, in Emerging Asia (excluding China), at around 130%. At a country level, Indonesia stands out among the region"s largest economies in terms of the build-up of foreign-currency debt, although the rise has levelled off since 2015.
However, the increase in foreign-currency debt has been more than matched by foreign-currency reserve accumulation in Emerging Asia (ex. China), where aggregate reserves are now almost twice the level of foreign-currency debt. This is in clear contrast with other regions.
These reserves, along with generally strong external and fiscal profiles, act as a buffer against external financing risks and pressure on sovereign credit profiles. Indonesia, India, and the Philippines stand out for their current account deficits, which have left them vulnerable to currency pressures and declines in reserves. But these deficits are moderate, and policymakers are taking steps to contain them. All of Asia"s sovereign credits are on Stable Outlook, with the exception of Pakistan, which is on Negative.
Fitch’s surveys also showed contrasting views on China, with 60% of attendees at the conference in Hong Kong believing the economic outlook was negative, compared with 40% in Singapore and 44% in New York, where more attendees expected policymakers to prop up growth. Investors further away from China may have been more influenced by robust sentiment in the US or focused on wider global issues.
Regulatory tightening begun in early 2017 is slowing China"s domestic demand. Policy has shifted towards easing in recent months, evidenced by the latest 100bp reserve requirement ratio cut on 7 October, but high debt levels and the authorities" deleveraging agenda mean that a large-scale credit stimulus is unlikely.
Fitch forecasts China"s growth to slow to 6.1% in 2019, from an expected 6.6% in 2018. A more aggressive policy response that causes a further build-up of the economy"s imbalances and vulnerabilities could create sovereign rating pressure.
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