Liquidity crisis in EM, Currency Devaluations and Consumption
By: Amit Bhushan Date: 20th Jan 2016
The liquidity crisis in most emerging markets with pull out foreign funds (read USD), is accentuating the collapse of capital markets in EM and also reducing avenues of borrowing for the local firms of most emerging markets. Partly, it's on account of the markets own behaviour and key player's (viz. Central Banks) reluctance - to build further reserves/accumulation of currencies that are likely to depreciate, say on account of quantitative easing or otherwise viz. Euro/ JPY or RMB in the given scenario. This is because the held reserve is still required to be reported in effective dollar value and a depreciation in effective value is likely to sound as "loss" on their books.
Same thing is true for corporates who report financials is either local currency or USD. This is leading to a glut in commodities, especially where storage is challenge or where consumption in significantly down/showing de-growth/ reduced growth. For food commodities with relatively in-elastic demand at global levels, the governments (in emerging as well as developed) need to ensure cheaper food for the poor/under-employed and unemployed and therefore even with currency depreciation, they need to ensure manageable prices and so a fall in effective USD terms.To get out of the situation, the word needs rising wages as well as rising consumption - at places where it can easily happen which is basically emerging markets, where there is a sustainable demand basis need and paying capacity.
The paying capacity might be questioned but the emerging markets have shown a relatively better ICOR (incremental Capital Output Ratio) i.e. if output is measured in quantity of goods produced & sold rather than currency value terms. The ability to service capital in absolute terms is also intact for most emerging markets in such scenarios. It is focus on this section that would help build up the consumption base and employment/wages. Usually the paying capacity is measured in value of widgets derived in easily convertible currencies and this creates a "halo" while what is only needed is return on capital employed in convertible currencies (as far as economic value is concerned). While this is true for investment perspective, though most corporates still use trading perspective in mind even while making investment decisions. This remains the case even when trade is going down while countries are increasingly seek investments to ramp up domestic production and jobs.
The EM in question will have to achieve cost structures whereby which some its produce can be exported in order to repay the Fx inflow. However what we are witness to is reverse i.e. such markets say for example China or others, where currency is falling and the wages either stagnant or falling. The lack of Chinese corporates to push invoicing in RMB as well as their imports in RMB as well is part of the problem. Easier loans in RMB to emerging market entities in such a scenario might help to internationalize RMB and allow Chinese businesses to expand. Such a push and getting market acceptance for the practice could internationalize RMB more, however given geopolitics in South East Asia and beyond, this has not really taken off to the extent that could have mitigated the problem to some extent by helping RMB reserves to grow (Not sure what the response of such institutions would be in case US were to again go for Quantitative easing).
Lack of open markets and transparency for free trade in the currency may also be part of the problem. It is also true that the other emerging markets also tend to re-position their currency basis competitive situation for exports rather than sustaining domestic production & consumption. It's often peculiar because these countries need to maintain their creditworthiness as well as protect accumulated reserves position from erosion as a priority rather than manage domestic demand alone. Thus external factors weigh in such situation much more than internal balancing position since the rulers are scared of possibility of capital flight and irrational exuberance amongst masses, taking over. Past experience has shown that such speculative behaviour has long term repercussion and thus become "urgent" rather than "important" with governments spending considerable time in fighting these issues which keep recurring every few years.Sorting out these issues may impact global opportunity spectrum in manner which may not be in line with the expectation of current stakeholders.
These may be within the emerging economies who tend to profit from such turmoil and may have stake in the "un-balance" in the global economic opportunity spectrum to remain as it is. A fundamental alteration in the established mechanisms with unknown mechanism is not desired by many, in any case. This allows time for some of the more developed counterparts to get their act together, in the view that the emerging markets perhaps are much more disturbed. The sustainability of demand in these markets may be a challenge given the relative cost structures of their produce and its competitiveness in the international markets. Although this may take a bit longer time to re-establish, as is the case.
In the meantime the emerging countries may need to continue to re-adjust basis external situation and try working out swap arrangements with key trade partners who may be willing to lend a helping hand or where interests collude, so that they can maintain consumption and jobs in the domestic arena, though effort may be made to minimize competitive devaluation which is likely to hit almost all emerging markets much more severely than otherwise.
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By: Amit Bhushan Date: 20th Jan 2016
The liquidity crisis in most emerging markets with pull out foreign funds (read USD), is accentuating the collapse of capital markets in EM and also reducing avenues of borrowing for the local firms of most emerging markets. Partly, it's on account of the markets own behaviour and key player's (viz. Central Banks) reluctance - to build further reserves/accumulation of currencies that are likely to depreciate, say on account of quantitative easing or otherwise viz. Euro/ JPY or RMB in the given scenario. This is because the held reserve is still required to be reported in effective dollar value and a depreciation in effective value is likely to sound as "loss" on their books.
Same thing is true for corporates who report financials is either local currency or USD. This is leading to a glut in commodities, especially where storage is challenge or where consumption in significantly down/showing de-growth/ reduced growth. For food commodities with relatively in-elastic demand at global levels, the governments (in emerging as well as developed) need to ensure cheaper food for the poor/under-employed and unemployed and therefore even with currency depreciation, they need to ensure manageable prices and so a fall in effective USD terms.To get out of the situation, the word needs rising wages as well as rising consumption - at places where it can easily happen which is basically emerging markets, where there is a sustainable demand basis need and paying capacity.
The paying capacity might be questioned but the emerging markets have shown a relatively better ICOR (incremental Capital Output Ratio) i.e. if output is measured in quantity of goods produced & sold rather than currency value terms. The ability to service capital in absolute terms is also intact for most emerging markets in such scenarios. It is focus on this section that would help build up the consumption base and employment/wages. Usually the paying capacity is measured in value of widgets derived in easily convertible currencies and this creates a "halo" while what is only needed is return on capital employed in convertible currencies (as far as economic value is concerned). While this is true for investment perspective, though most corporates still use trading perspective in mind even while making investment decisions. This remains the case even when trade is going down while countries are increasingly seek investments to ramp up domestic production and jobs.
The EM in question will have to achieve cost structures whereby which some its produce can be exported in order to repay the Fx inflow. However what we are witness to is reverse i.e. such markets say for example China or others, where currency is falling and the wages either stagnant or falling. The lack of Chinese corporates to push invoicing in RMB as well as their imports in RMB as well is part of the problem. Easier loans in RMB to emerging market entities in such a scenario might help to internationalize RMB and allow Chinese businesses to expand. Such a push and getting market acceptance for the practice could internationalize RMB more, however given geopolitics in South East Asia and beyond, this has not really taken off to the extent that could have mitigated the problem to some extent by helping RMB reserves to grow (Not sure what the response of such institutions would be in case US were to again go for Quantitative easing).
Lack of open markets and transparency for free trade in the currency may also be part of the problem. It is also true that the other emerging markets also tend to re-position their currency basis competitive situation for exports rather than sustaining domestic production & consumption. It's often peculiar because these countries need to maintain their creditworthiness as well as protect accumulated reserves position from erosion as a priority rather than manage domestic demand alone. Thus external factors weigh in such situation much more than internal balancing position since the rulers are scared of possibility of capital flight and irrational exuberance amongst masses, taking over. Past experience has shown that such speculative behaviour has long term repercussion and thus become "urgent" rather than "important" with governments spending considerable time in fighting these issues which keep recurring every few years.Sorting out these issues may impact global opportunity spectrum in manner which may not be in line with the expectation of current stakeholders.
These may be within the emerging economies who tend to profit from such turmoil and may have stake in the "un-balance" in the global economic opportunity spectrum to remain as it is. A fundamental alteration in the established mechanisms with unknown mechanism is not desired by many, in any case. This allows time for some of the more developed counterparts to get their act together, in the view that the emerging markets perhaps are much more disturbed. The sustainability of demand in these markets may be a challenge given the relative cost structures of their produce and its competitiveness in the international markets. Although this may take a bit longer time to re-establish, as is the case.
In the meantime the emerging countries may need to continue to re-adjust basis external situation and try working out swap arrangements with key trade partners who may be willing to lend a helping hand or where interests collude, so that they can maintain consumption and jobs in the domestic arena, though effort may be made to minimize competitive devaluation which is likely to hit almost all emerging markets much more severely than otherwise.
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