War in Ukraine poses some complications for EM growth

War in Ukraine poses some complications for EM growth

Most emerging markets have minor direct linkages to Russia and Ukraine, but the conflict is a global shock that complicates the EM outlook just as the covid crisis starts to recede, says the IIF.

“We assess EM external vulnerability, comparing it to episodes such as the taper tantrum or the 2014 Ukraine conflict. We also discuss the impact commodity prices could have on EM energy importers. External vulnerability is not flashing red in most EMs,” it says.

Current account deficits are unusually small due to booming exports on the back of high commodity prices. Unfortunately, EMs have not gone through a long period of strong growth for years, which caps the size of current account deficits.

Colombia and Chile stand out, as imbalances have grown recently due to expansionary policies. Reserve buffers are generally strong, especially compared to a decade ago.

If high commodity prices persist, importers like India will see widening current account deficits, but not as high as in the taper tantrum. War in Ukraine is a major global shock that EMs enter under a level of external vulnerability that is not the highest on record.

“EM external accounts look good coming out of the covid crisis. Trade balances, a high-frequency proxy for current account deficits we monitor regularly, do not point to rapidly growing external imbalances. We compare trade balances in 21H2 to the same period in 2019 to track where EMs stand relative to the pre-pandemic period. Several commodity exporters show stronger trade balances (Exhibits 1 and 2).

“In a few countries including India and Colombia, we are tracking worse trade balances. In general, the qualitative picture is one of solid import growth more than offset by booming exports.

“In this context, we expect small current account deficits this year, and even unusual surpluses in countries like South Africa (Exhibit 3). Current account deficits will be modest by historical standards.”

Crimea and War

As a reference point, when conflict in Crimea started in 2014, several EMs were running deficits of more than 4% of GDP. Figures were even higher in the run-up to the taper tantrum.

The shock now is bigger than in 2014 but in general EM external financing needs are not high by historical standards (Exhibit 4). Reserve buffers are strong.

Most EMs fare well under the rule of thumb that reserves should cover at least 100% of gross external financing needs (Exhibit 5).

Colombia and Chile are notable exceptions to the trends discussed above. They are both commodity exporters, but expansionary policies have pushed up domestic demand and spilled over to the external accounts.

In relative terms, we think Chile will make faster progress at reducing imbalances. Fiscal adjustment is very aggressive this year and, coupled with rate hikes, will cool down the economy, lowering inflation and the current account deficit. In contrast, gradual fiscal consolidation in Colombia will not do much to reduce external risk.

Growth shock

Commodity prices will also shape EM external accounts this year. For many exporters, rising prices could strengthen current accounts further (a negative growth shock would do so too via weakening imports).

Importers like India and Turkey sit at the other end of the spectrum. In India, a relatively sluggish recovery will weigh on import volume growth, but oil price effects will dominate.

“At the range of oil prices of the last few months, India’s current account deficit could easily surpass 2.5% of GDP. However, we do not see deficits coming anywhere close to those in the run-up to the 2013 taper tantrum (Exhibit 6).”

More from the IIF can be found here.