Two major “shocks” for emerging economies

Jorge Sicilia, Chief Economist at the BBVA Group, participated in a panel discussion on  the global outlook and its impact on the Middle East and North Africa, moderated by Sergi Lanau, Deputy Chief Economist at the Institute of International Finance (IIF). James McCormack, Managing Director and Global Head of Sovereign and Supranational Ratings; Monica Malik, Chief Economist at Abu Dhabi Commercial Bank; and Radwan Shaban, Chief Economist at Arab Bank also participated in the panel. The debate focused on the political uncertainty stemming from the changing macroeconomic and financial situation in the world. Panel discussants also addressed issues such as monetary policy in the U.S. and Europe and the implications for MENA; the consequences of the trade war and U.S. sanctions; private equity flows to emerging markets; and the risk of a correction in capital markets.

For Sicilia, emerging markets are currently facing two major shocks. On the one hand, the rationalization of liquidity due to the change in monetary policy in the U.S. and Europe, and on the other, international trade disputes - a completely unexpected phenomenon a few years ago. Most analysts believe that the impact on international trade has been relatively moderate so far, but if the threats actually materialize, the impact would be significant.

How have emerging countries reacted to these two shocks? BBVA’s Chief Economist feels that they have managed fairly well in general. He points to the capital flows from emerging economies as evidence, which are highly concentrated in countries like Argentina and Turkey.  These two large countries that have experienced these episodes of volatility have two things in common: both have external vulnerabilities (a high current account deficit, high foreign currency debt and relatively low reserves to cover these two imbalances) and they did not apply appropriate economic policies given these weaknesses and the changing economic environment.

Although after this shock, both economies were forced to react with measures to correct these policies, the damage had already been done. The other emerging economies have handled these international shocks much better. However, the context will remain difficult for emerging economies in the future: interest rate hikes will continue and trade tensions will not disappear in the short- term. Jorge Sicilia therefore believes that emerging economies should adopt “prudent monetary and fiscal policies that adapt to these shocks,” with some help from flexible exchange rates to absorb the impact. However, he is convinced that it is an “idiosyncratic” - not systemic - problem and can remain that way if these countries take appropriate measures.

Turning to the eurozone, the experts discussed the situation in Italy, which has posed a challenge to Europe’s fiscal stability with its 2019 budget. In Jorge Sicilia’s opinion, it’s “unfortunate” to be in this situation after the crisis that took place in Europe and all of the steps taken to create a banking union, which remains pending. It comes at a bad time for the eurozone, when growth is down and the employment rate is moving toward lower potential growth than the current rate. In addition, the European Central Bank has started to normalize its monetary policy and will stop buying eurozone sovereign debt starting early next year.

This clash is uncalled for from an economic standpoint. In his opinion, “Italy’s problems will not be resolved by an expansive fiscal policy” because they are more structural in nature. In fact, this fiscal stimulus could have a contractionary effect given the increase in sovereign spreads. The solution lies in “finding a manageable fiscal policy that does not lead to confrontation with Europe,” which will take more time. Similarly, for BBVA’s Chief Economist, Italy has a very high debt-to-GDP ratio, but it is also capable of managing a primary surplus over 3%. If it wants to improve its growth, it will not come from an expansive fiscal policy unless the more structural barriers to growth are addressed.

To conclude, the moderator asked the members of the panel what risks concern them the most in the short-term. Jorge Sicilia believes that cycles change as a result of imbalances in economies. These imbalances cause reactions in the markets, and eventually turn into shocks. In his opinion, the greatest risk at the moment is the tension in international trade -  tension he feels the markets have underestimated. He maintains that they have the potential to alter the open markets that have prevailed over the last 40 years, and especially the set of international rules created to regulate international trade, which are being undermined.