Emerging market funds are being hit with increased withdrawals as investors worry that soaring food and oil prices will fuel social and political tensions, while rising interest rates in the United States will make it harder for cash-strapped governments to meet hefty debt repayments.
For the past few decades, investment managers have touted the benefits of investing in emerging markets, claiming that their higher economic growth rates translate into bigger opportunities for local companies, and that falling trade barriers would improve their access to developed markets.
But returns have been disappointing over the past decade. Most emerging market index-linked funds have delivered average annual returns of less than 4 per cent over the 10-year period.
But investors fear that the outlook is becoming even bleaker for emerging markets, as Russia’s invasion of Ukraine is propelling food and energy costs even higher, at a time when the US central bank is pushing up interest rates, which has caused global financing conditions to tighten.
Investors are worried that emerging countries will be hit by a wave of social unrest as global food prices have climbed to their highest ever level after Russia’s invasion of Ukraine.
Soaring prices for cooking oils, cereals and meats meant that food commodities cost a third more than the same time last year, according to the UN Food and Agriculture Organisation.
Russia’s invasion of Ukraine has disrupted the supply of key commodities, including wheat, corn, barley and sunflower oil.
(Over the past five years, the two countries together have accounted for almost 30 per cent of the world’s wheat exports, 17 per cent of corn, 32 per cent of barley (a crucial source of animal feed), and 75 per cent of sunflower seed oil, an important cooking oil.)
The war has helped push cereal prices up 17 per cent over the past month, while the cost of vegetable oil has jumped 23 per cent.
The surge in food costs has a bigger impact in less affluent countries. In advanced economies, food typically accounts for less than 20 per cent of consumer spending. In developing countries, a much higher proportion of the household budget is spent on food.
Even before the war, food prices were pushing higher, following serious droughts and floods in major food producing regions, and because of shipping delays and rising freight costs caused by the coronavirus pandemic.
There are growing fears that food prices will push even higher, as the war in Ukraine makes it unlikely that more than one-third of the country’s cropland will be planted this year.
Meanwhile, many countries are bracing for smaller harvests as farmers reduce their use of fertiliser, the price of which has climbed to a record high amid a steep drop in Russian supply. Russia is the world’s largest fertiliser exporter, accounting for about 15 per cent of global supply.
At the same time, rising energy costs will exacerbate cost-of-living pressures in emerging markets given that energy typically accounts for between 5 per cent and 10 per cent of measured inflation in these countries.
The oil price surged above $US100 a barrel for the first time since 2014, and natural gas prices vaulted sharply higher following Russia’s invasion of Ukraine. At present, oil is trading just under $US100 a barrel.
Some emerging economies which are major exporters of fossil fuels – such as Saudi Arabia and Malaysia – benefit from soaring energy prices, which lift their export revenues and boost government revenues.
But emerging countries that are dependent on energy imports – such as India, Thailand and Turkey – face a blowout in their import bills and higher domestic inflation.
Investors also fret that emerging markets will be the most serious casualties from tighter US monetary policy.
Last month, the US Federal Reserve raised official interest rates for the first time since 2018, and pencilled in six more rate rises this year.
The Fed has also signalled that it plans to shrink its $US9 trillion ($12.15 trillion) balance sheet at a rapid rate, which will lead to a significant tightening in global financial conditions. And this will likely make it more difficult, and more expensive, for emerging markets to refinance their growing debts.
According to a World Bank report, Finance for an Equitable Recovery, released in February, emerging economies are taking longer to recover from the pandemic than advanced economies.
“The evidence available so far suggests that the economic effects of the pandemic will be more persistent and severer for emerging economies,” it says.
“For example, after the collapse in per capita incomes across the globe in 2020, 40 per cent of advanced economies recovered and exceeded their 2019 output level in 2021.”
“The comparable share of countries achieving per capita income in 2021 that surpassed their 2019 output is far lower for middle-income countries, at 27 per cent, and lower still for low-income countries, at 21 per cent, pointing to a slower recovery in poorer countries.”
The World Bank report also notes that governments in many emerging countries introduced unprecedented emergency support measures – such as cash transfers to households and credit guarantees for businesses – to cushion the economic impact of the pandemic.
But this has had the effect of causing the debt levels of many developing countries – which were already at record highs before the pandemic – to balloon even further.
“The pandemic has led to a dramatic increase in sovereign debt,” the report says.
“The average total debt burdens among low- and middle-income countries increased by roughly 9 percentage points during the first year of the pandemic … compared with an average increase of 1.9 percentage points over the previous decade.”
And, it says, interest payments in emerging economies have been rising even before the Fed raises interest rates.
“Although interest payments in high-income economies have been trending lower in recent years and account, on average, for a little over 1 percentage point of GDP, they have been climbing steadily in low- and middle-income economies.”
The problem is that these interest payments will increase further as the Fed pushes US interest rates higher.
What’s more, much of the borrowing is denominated in US dollars, and the greenback tends to rise in tandem with higher US interest rates.
This means that emerging markets could be hit with another shock, as their local currency depreciates against the US dollar, which will make their debt repayment even more onerous.
