Economic Views – Emerging Markets External Imbalances in 2022

Economic Views – Emerging Markets External Imbalances in 2022

EM current account deficits have been unusually small or inexistent in the last two years. Initially, favorable external balances were the flipside of deep recessions. Imports fell with domestic demand, shrinking external deficits. In the later stages of the covid crisis, commodity prices lifted exports, more than offsetting the recovery in imports. Benign external balances helped EMs cope with weak capital flows.

Despite easy financial conditions in the US, our trackers show outflows in 2021 from local bonds and equities in EM ex China. We assess the latest high-frequency data to see where current account deficits are headed in 2022.

Quite a few countries are still running smaller trade deficits than in 2019. Imports generally exceed pre-pandemic levels relative to GDP, but strong exports prevent imbalances.

Colombia’s remarkable exception

Trade and current account deficits are wide despite favorable oil prices, a risky setup ahead of uncertain elections this spring. Chile’s trade balance is not out of the ordinary but overall external imbalances are high given copper prices.

“On balance, we are more concerned about Colombia. India’s deficit is also widening but we do not expect the kind of critical imbalances we saw in the run-up to the taper tantrum. Sharp depreciation will shrink Turkey’s large trade deficit partially. EM current account deficits will widen gradually in 2022 but, barring severe drops in commodity prices, we do not think external imbalances will become a systemic issue,” says analysts.

“We look at trade data in the second half of 2021 as a ‘real-time’ gauge of EM current account deficits. We compare these figures in percent of GDP to the same period in 2019, the last pre-pandemic year, in Exhibit 1. We benchmark available ytd data in 2021 against the last ten years in Exhibit 2.”

External balances look good in several countries, especially considering that 2019 was not a year of especially wide EM deficits. Unlike the initial phase of the pandemic, import compression is not driving trade balances. Except in South Africa, imports are well above pre-pandemic levels, but strong exports keep a lid on trade deficits (Exhibit 3).

“South Africa is running unprecedented current account surpluses due to booming exports and low imports, but we think the underlying external position is not so strong. Imports of goods and services are 2-3% of GDP below normal levels due to poor economic activity (Exhibit 4).”

If growth recovers, current account surpluses will shrink and pressure on the currency will increase. In a few cases, import growth outstripped exports. Turkey is a particular one. Even though imports continued to increase in December, we expect currency devaluation to shrink the trade deficit despite a domestic credit boom that will partially support domestic demand and imports. In India’s case, the combination of a rising oil import bill and solid non-

CURRENT ACCOUNT DEFICITS

Chile and Colombia are running current account deficits of 5-6% of GDP, largely driven by loose fiscal policy. In Chile’s case, the 2022 budget aims for spending cuts of 7% of GDP, which together with tighter monetary policy would end external imbalances quickly. We do not think Boric’s government can do such radical cuts when it takes office but still expect enough policy tightening to lower current account deficits to slightly safer levels.

In relative terms, we are more concerned about Colombia, where imports are rising sharply, negating the positive impact of high oil prices and strong non-oil exports (Exhibit 5).

Modest fiscal deficit reduction plans compared to Chile suggest Colombia will get to uncertain elections in May running wide current account deficits. The current account balance net of the often-large financial operations of foreign-owned companies illustrates the contrast between Chile and Colombia (Exhibit 6). Colombia is running a much larger ‘core’ current account deficit.

“EM imports are generally solid, a setup often associated with high current account deficits. However, strong exports neutralized the impact of rising imports on external imbalances. If commodity prices remain resilient, we expect manageable widening of EM current account deficits. We do not think external imbalances will grow enough in 2022 to make EM resemble the taper tantrum. Colombia’s and Chile’s twin fiscal and current account deficits stand out as risky, Colombia’s more so.”