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At a time when US-China trade tensions are resurfacing, troubles are coming to the emerging market economies not as single spies but as battalions. This has to be of great concern for the world economic outlook. This is especially the case since, unlike in past episodes of emerging market weakness, these troubles are coming not when the Federal Reserve is tightening monetary policy but rather when the Fed is moving to a looser policy stance.
Last month, in its World Economic Report update, the IMF pinned its hopes of a world economic rebound in the second half of this year on a pickup in economic growth in the emerging markets in general and in Argentina and Turkey in particular. Sadly, all of the indications are that this pickup is not going to happen especially given the resumed pronounced weakness in the Argentine peso and the Turkish lira.
A merchant counts Turkish lira banknotes at the Grand Bazaar in Istanbul, Turkey, March 29, 2019. REUTERS/Murad Sezer
There can be little doubt that Argentina and Turkey are now in the grips of serious currency crises that are creating a vicious economic and political cycle that could lead to them ultimately defaulting on their debts. Following steep declines in their currencies last year, since the start of this year the Argentine peso and the Turkish lira have lost more than a further 15% in their values.
There is every prospect that these two countries’ currency crises will deepen in the months ahead as Argentina heads to a general election in October that could see the return of Christine Fernandez de Kirchner as president and as Turkey’s President Erdogan has heightened political uncertainty in his country by forcing a rerun of the Istanbul mayoral election.
The deepening Argentine and Turkish currency crises are not occurring in isolation. For a start, both the Iranian and Venezuelan economic collapses are deepening as the US substantially tightens sanctions on these two rogue countries. However, very much more important for the world economic outlook are disappointments in a number of major emerging market economies. Those disappointments heighten the probability that we will get contagion to the rest of the emerging markets from Argentina and Turkey’s deepening economic woes.
Among those emerging market economies that have to be of great concern is Brazil. At a time that Brazil is running a budget deficit of around 7% of GDP and its public debt is on a path to soon reach 100% of GDP, the new Brazilian government is riven by divisions that make it unlikely that it will be in any position to address that country’s serious economic imbalances. As if to underline this point, Brazil’s much needed pension reform keeps getting diluted and delayed.
It is also hardly comforting that the new Mexican government seems to be on a market unfriendly path, as underlined by its actions in the energy sector. That policy shift is undermining both external and domestic investor confidence in that country. Similarly, the waning political fortunes of the African National Congress in South Africa’s recent election, makes it unlikely that much needed economic reforms will be adopted in that country any time soon.
All of this has to raise serious questions about the wisdom of President Trump’s aggressive America First trade policy. With fragile emerging market economies, a slowing European economy, and issues like Brexit yet to be resolved, the last thing that the world economy now needs is a further economic slowdown in China, the world’s second largest economy. Such a slowdown would almost certainly result from a renewed hike in US import tariffs.