The world’s riskiest markets are entering crisis with scarce dollars

(Bloomberg) – Hospitals postpone operations in Sri Lanka. International flights suspended in Nigeria. Car factories closed in Pakistan.

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In some of the world’s most vulnerable developing countries, the situations on the ground are appalling. Dollar shortages hinder access to everything from raw materials to medicines. Meanwhile, governments grapple with their debts as they chase rescue packages from the International Monetary Fund.

It forces a rethink of the upbeat emerging-market consensus that dominated Wall Street several months ago. Admittedly, few expected the problems facing certain frontier economies this year to be resolved, but the pain has worsened alongside a greenback rebound.

While the problems on the periphery of the developing world are unlikely to affect the asset class as a whole, some say asset managers will become increasingly tactical in their investment allocations in the coming months.

“There is a real crisis brewing in these troubled countries and for some it could get even worse,” said Hasnain Malik, emerging and frontier markets strategist at Tellimer in Dubai. “Investors will need to be even more vigilant in screening for vulnerability and differentiating country risks to avoid being surprised by the next Ghana or Sri Lanka.”

In Pakistan, factories have shut down operations in recent months because they ran out of hard currency to import raw materials. In Sri Lanka, the government has set a limit of 20 liters of fuel per person per week and government hospitals are postponing non-urgent surgeries due to shortages of medicines and other medical supplies.

Not to mention the international airlines that have suspended flights to Nigeria due to the difficulty of repatriating dollars from the country. In Bangladesh, energy producers are requesting $1 billion in foreign currency from the central bank for fuel imports to avert an impending energy crisis. Malawi is also facing shortages of pharmaceuticals, fertilizers and diesel amid falling imports due to the dollar crisis.

JPMorgan Chase & Co.’s Next Generation Markets Index, which tracks the dollar debt of what it calls pre-emerging countries, posted a 0.4% drop last month, its biggest since September. And amid the dollar’s recent strength, the currencies of Ghana, Egypt, Pakistan and Zambia have fallen much more this year than their global counterparts.

This has led some asset managers to adopt a more cautious approach, a departure from the broad emerging market optimism seen at the start of the year.

“These countries are in economic meltdown, and some, like Pakistan, are teetering on the brink of another bankruptcy,” said John Marrett, a senior analyst with the Economist Intelligence Unit in Hong Kong. “Large parts of their economies are struggling. The currencies are also worth much less.”

Frontier markets may continue to face external challenges this year, including a still-strong U.S. dollar, high yields and difficulties accessing the bond market, Fitch Ratings wrote in a report Monday. A fall in reserves could also lead to more credit rating downgrades, it warned.

Meanwhile, more risk-averse money managers are instead chasing attractive yields on debt from governments that have managed to control budget deficits and keep currencies relatively stable. Barclays Plc has named Mexico and Colombia as countries moving towards further fiscal consolidation.

Dangerous Cycle

For countries like Sri Lanka, the problems started years ago when officials spent valuable reserves of hard currency to keep local exchange rates artificially high.

But it was the Russian war in Ukraine and the Federal Reserve’s aggressive policy tightening that propelled the dollar to generational highs. That pushed many frontier economies closer to the brink as rising energy and food prices emptied their coffers.

“It’s tempting to say there’s an EM crisis because of the Fed’s tightening, but that’s taking away human choice from policymakers in certain countries that have pursued unsustainable fiscal policies,” said Samy Muaddi, head of emerging markets fixed income at T Rowe. Price in Baltimore. “That said, tighter financial conditions are now exposing policies in some of these countries that are proving to be unsustainable.”

About two dozen countries are lining up for aid from the International Monetary Fund, though progress has been slow for countries hampered by debt negotiations. Over the past year, several debt-laden countries — including Egypt, Pakistan and Lebanon — have slashed their exchange rates in an effort to free up bailout funding, with currency traders bracing for a potential wave of devaluations.

Brendan McKenna, an emerging-markets economist and strategist at Wells Fargo Securities LLC in New York, says those willing to take the risk can find opportunities in countries with a clear reform agenda and a path to support from official lenders, such as the IMF.

“Pakistan, Sri Lanka and Ghana – maybe now is not the time to put capital there,” he said. “But Egypt could be an opportunity if the IMF program succeeds in supporting the economy while implementing tough reforms.”

What to watch

  • China will take center stage as the National People’s Congress, which kicked off on March 5, will set the economic and social agenda for the year ahead. The country will also release data on exports, consumer price inflation and factory prices in the coming week.

  • Traders will want to monitor inflation data out of the Philippines, Thailand, Russia, Mexico and Chile.

  • Poland’s central bank is likely to keep its key interest rate at 6.75% as the country’s tightening cycle comes to an end. Bloomberg Economics expects the next step to be a rate cut, possibly in the second half of 2023.

  • Bank Negara Malaysia is likely to leave its reference rate unchanged.

  • Peruvian policymakers will meet on Thursday to set their policy rate.

  • According to Bloomberg Economics, Brazil’s IPCA data for February is likely to shed light on the pace of disinflation.

–With help from Selcuk Gokoluk, Colleen Goko, Anusha Ondaatjie, Faseeh Mangi and Liau Y-Sing.

(Updates with Fitch warning about rating downgrades in 11th paragraph)

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