PH seen among most vulnerable to US Fed policy reversal

The Philippines is among the 10 emerging markets (EMs) deemed “most vulnerable” to shockwaves from the possible withdrawal of the US Federal Reserve’s massive monetary stimulus, analysts from Japanese investment house Nomura said.

Nomura’s “troubled 10” EM list also included Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa and Indonesia.

“We disagree with those who believe that EM is in a more resilient position now than it was on the eve of the 2013 taper tantrum,” Nomura said in a global research note dated Aug. 25 written by analysts Rob Subbaraman and Rebecca Wang.

The study flagged new sources of vulnerability for EMs, citing a combination of chronically weak growth, rising inflation and a marked deterioration in fiscal finances. And yet, it noted that real policy rates remain “deeply negative” in many EM countries, referring to a situation where inflation rate was higher than interest rate.

“The prospect of the Fed normalizing monetary policy amid China’s slowing economy is a dreadful combination for EM, only to be made worse by the three EM vulnerabilities that we have found lurking in the shadows,” the research said.

Nomura warned of a growing EM bank-sovereign debt nexus that raised the risk of a so-called bank-sovereign doom feedback loop, a situation where weak banks could destabilize governments that support them, resulting in a “vicious cycle.”

Nomura said Brazil and India appeared most at risk of such a doom loop—the same phenomenon at the heart of the 2009-2010 European debt crisis.

“We debunk the idea that, just because EM has attracted smaller cumulative portfolio inflows since COVID-19, it is less susceptible to large capital flight. Gauged by portfolio liabilities, as opposed to cumulative portfolio inflows, we show how many EMs are likely more susceptible now than on the eve of the 2013 taper tantrum, once asset revaluation effects are taken into account,” the research said.

From a saving-investment framework, Nomura also argued that EMs’ extraordinarily large fiscal deficits would likely leak into sizable current account deficits—listing Colombia, Peru, Romania, Turkey and South Africa as the most vulnerable.

Nomura warned that economic fundamentals in many EM countries—which have already deteriorated over the past year—might worsen further in the year ahead, heightening the risk of financial crises as global rates rise.

“We believe many EM central banks may have overreached by easing monetary policy too far—including delving into QE (quantitative easing) for the first time—which has left foreign investors poorly compensated for the weakened economic fundamentals,” Nomura said.

Quantitative easing refers to the infusion of new money into the financial system by a central bank without tinkering with the policy interest rate, such as by buying bonds held by banks.

An important lesson from the large number of past EM crises is that risk premia do not follow a monotonic process or increasing steadily as risk increases, the research said.

Rather, investors’ perceptions of risk tend to develop in a binary “on or off” fashion, triggering a sudden repricing of risk, it added.

During the taper tantrum of 2013, Nomura listed only five EMs in its “troubled” list, namely, Brazil, India, Indonesia, South Africa and Turkey.

“Bringing together all of our analyses, we now warn of a longer list of vulnerable countries that we have coined, the “troubled 10”: Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa, Indonesia and the Philippines,” it noted.

If foreign investors start to become more concerned about the vulnerabilities highlighted in its report, Nomura said the resulting capital outflows and EM currency depreciation could have amplifier effects.

“One channel is through weaker EM currencies raising the cost of servicing EM foreign currency-denominated debt. Another is a deterioration in the terms of trade for large EM commodity exporters, notably in Latin America and the Middle East, if a stronger US dollar and a weaker EM economic outlook results in a slump in commodity prices,” it said.