The “Troubled Ten” in EM

We warn of ten economies that appear most vulnerable: Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa, Indonesia and the Philippines.

  • The prospect of the Fed normalizing monetary policy and China’s slowing economy is a dreadful combination for EMs, which have developed new sources of vulnerabilities.
  • We debunk the notion that EM economies are less susceptible to capital flight, and demonstrate how the twin deficit challenges could reemerge.
  • We warn of ten economies that appear most vulnerable: Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa, Indonesia and the Philippines.

Covid-19 has changed the sources of emerging market (EM) vulnerability. Many EM economies now face a combination of chronically weak growth, rising inflation and a marked deterioration in fiscal finances. At the same time, many are still grappling with new waves of Covid-19, amid limited access to vaccines and overburdened health systems. Add to this the prospect of the US Federal Reserve normalizing monetary policy amid China’s slowing economy, and it becomes a dreadful combination for EMs.

The “troubled ten” are Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa, Indonesia and the Philippines. The economic fundamentals in these EM countries have deteriorated over the past year and are likely to worsen further in the year ahead, heightening the risk of financial crises as global interest rates rise.

EM central banks have recently started raising rates, but many are only matching the rise in inflation, resulting in still deeply negative real rates. Some EM central banks may have overreached in not providing enough interest rate return (i.e., risk premium) to foreign investors to compensate for weaker economic fundamentals.

Previously, we had warned of the EM bank-sovereign debt nexus, with 60% of sovereign debt issued after January 2020 ending up on domestic bank balance sheets. To this, we add two more concerns to our downbeat EM outlook. The first is to debunk the notion that, just because EMs have attracted smaller cumulative portfolio inflows since the pandemic started, they are less susceptible to large capital flight. It is the cumulative capital inflows over a longer time frame that matter more, and these portfolio inflows were exceptionally strong over 2014 to 2019.

Secondly, large current account deficits are likely to quickly re-emerge in coming years. Alongside large fiscal deficits, this will result in twin deficit challenges in EM. At the height of the pandemic last year, current account deficits in EM countries narrowed sharply, with some even swinging to surplus due to the collapse in domestic demand and imports. The subsequent surge in commodity prices also benefited EM commodity exporting countries. If the vaccination rollout accelerates in the next 12-18 months, the large fiscal deficits in many of the EM countries could leak into sizable current account deficits relatively quickly.

Overall, EMs are not in a more resilient position now than they were on the eve of the 2013 “taper tantrum” – when financial markets worldwide, and especially in EMs, declined sharply on US Federal Reserve policy moves to scale back its bond-buying program. Compared to 2013, many countries now have smaller current account deficits, larger FX reserves and have attracted only modest cumulative portfolio inflows recently. However, EMs have developed new sources of vulnerability, and real policy rates remain deeply negative in many of them.

Read our full report on the “troubled ten” here.


    Rob Subbaraman

    Rob Subbaraman

    Head of Global Macro Research

    Rebecca Wang

    Rebecca Wang

    Macroeconomic Research Analyst, Asia ex-Japan


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