In every dislocation, there is an opportunity. For investors in alternative assets, the short-medium term dislocation wrought by COVID-19 in emerging markets presents an advantageous moment to allocate capital.
As emerging markets (EMs) batten down the hatches to confront the health crisis resulting from the coronavirus pandemic, policymakers are focused on containing the corollary economic fallout within their respective countries. As COVID-19 reverberates across the world, Indo-Pacific countries are contending with the ricocheting of the virus, out from the epicenter of Asia, and returning to their shores, potentially via imported cases.
In terms of capital flows to EMs, emerging and frontier markets often witness substantive outflows with economic volatility in China, and also with a downturn in commodity prices. <1> Since the start of 2020, with activity brought to a standstill across large parts of China, and with oil prices hitting 18-year lows, EMs have suffered colossal capital outflows in Q1. According to IIF, the number is ‘unprecedented’, and exceeds outflows during the Great Financial Crisis (GFC), the taper tantrum of 2013, and market volatility in China in 2015. <2>
In some ways, EMs are in a better position to navigate external shocks than they were during the Asian crisis of the late 1990s, having implemented macroprudential measures since the GFC. <3> These include: moving from fixed to floating exchange rates; reducing the fiscal deficit; and bolstering foreign exchange flows. However, the colossal coronavirus-related capital outflows are likely to be immensely destabilising, and may result in imported inflation via rapid depreciation of local currencies, as well as an increase to sovereign borrowing costs.
Moreover, while central banks and governments in advanced economies launch giant ‘bazookas’ of monetary and fiscal policy, many EMs do not harbour the fiscal space and hence the luxury to be able to respond with such measures. A substantial increase to M1 money supply can lead to inflation, particularly a risk for EMs. Some countries have nascent capital markets; and others may face a liquidity squeeze resulting in a potential USD shortage. Crucially, debt on EM non-financial corporate balance sheets now stands at $31.3 trillion <4> — with a bulk of the increase in leverage in recent years issued in USD. With swings in market volatility in the West, as investors move to cash and safe haven holdings, many EM corporates may come under significant duress and dramatic increases to debt service costs.
Looking to the real economy, the cessation of economic activity across the Eurozone is likely to have drastic implications for EM growth. Demand shock in Europe directly hits the manufacturing sectors of markets such as China, Vietnam, and India — countries which have increased their exports to EU-28 over the last decade. Additionally, with large swathes of populations in advanced economies under lockdown, tourism — which represents over 24% of GDP in the Philippines and 21% of GDP in Thailand <5> — is zapped, and along with it, tax revenues.Against this backdrop, downgrades from the rating agencies are likely — and accepting help from multilateral development banks (MDBs) should not be stigmatised. The IMF is poised to deliver — at current tally — some $50 bn of emergency financing to low-income and emerging markets via rapid disbursement. <6> The World Bank has also stepped up its emergency loan total to $14 bn <7> — designated both for containing the health crisis (such as providing Philippines with funds for medical equipment) as well as for shoring up jobs in real economy sectors, including tourism and manufacturing.
Maintaining broadband capacity will be also mission critical, so that students can continue their lessons without disruption in education programmes, which have blossomed across emerging markets. Proactive policymakers in Malaysia are making moves to auction solar projects in order to create jobs, in addition to issuing delaying taxation payments in the tourism sector. And in Vietnam, officials have decreased some transaction charges in order to shore up the local stock market. <8> Indeed, as the months of crisis go on, perhaps government officials will also be visionary in adapting fiscal policy to greater magnetize foreign direct investment into sectors of need.
In every dislocation, there is an opportunity. For investors in alternative assets, the short-medium term dislocation wrought by COVID-19 in EMs presents an advantageous moment to allocate capital. Certainly, while many executives are currently focused on their own operational and liquidity issues, the aperture for long-term investing — and prospect for buying low to sell high — is high. In consolidating one’s position, themes of conviction — and sectors for long-term growth and enterprise value — will come into focus.
It is said that generals always fight the last war, and that economists always fight the last crisis. If coronavirus is indeed a ‘once-in-a-century’ <9> pandemic, wreaking havoc on economies on war-like scale, then what are the prospects for long-term growth in developing Asia? The demographic dividend for some countries is undeniable; and when combined with the reality of increasingly ‘upskilled’ workforces and rich hubs for innovation and R&D, and the growth of purchasing power, the region remains ripe for long-term investing in private equity, real estate, and infrastructure. In the months to come, it is incumbent upon both policymakers, executives, and investors to collaboratively chart out paths for the future, in which we all have a common stake.
<1> It should be noted that the plunge in oil prices is also a boon for net oil importers in EMs — including Indonesia and India — and thus affords for more fiscal space for governments to potentially curtail subsidies in the power sector.
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Alexis Crow is Visiting Senior Fellow at ORF. She leads the Geopolitical Investing practice at PwC helping leading companies and asset managers to capitalise on ...Read More +