Coronavirus crisis and Emerging Markets: how serious is it?

The COVID-19 pandemic is a global phenomenon, but attention seems to be focused almost exclusively on developed countries. But how are the poorest countries facing the emergency? A report by the Federal Reserve of St. Louis highlights that, in the management of the crisis, one must not “think only for oneself”, both from a health and an economic-financial point of view. There’ll be a need for large liquidity injections which however will lead to currency collapses and inflationary crises.

coronavirus crisis emerging markets

If the emerging and developing countries are not put in a position to defeat the coronavirus, eradicating it only in the developed countries will be useless, because the contagion will return again and again, causing us to fall into a vicious circle. Just like in developed countries, the COVID-19 epidemic will have devastating economic consequences in the emerging world. With the aggravating circumstance that all of this will add to the previous difficulties.

In fact, many emerging countries have been hit by the health and economic emergency in the midst of major political transitions; above all, the poorest regions of the world do not have sufficient financial resources to face the crisis – and we know that an enormous amount of liquidity would be needed instead.

This is precisely the main question asked by the Federal Reserve of St. Louis: how to respond to the increased demand for liquidity in the poor and emerging countries of the world? A national central bank, squeezed between the need for new liquidity on the one hand and inflationary pressures on the other, what monetary policy should it implement?

Who will issue new liquidity to face the coronavirus crisis in Emerging Markets?

To answer the first question, the thoughts go to the International Monetary Fund and the World Bank, lenders of last resort. Both have already gone into action: the IMF has put on the table a loan capacity of 1,000 billion dollars, while the World Bank is asking bilateral creditors – including China – to suspend debt collection for a group of 76 low-income countries.

These are certainly useful actions, comments the Fed of St. Louis, but not enough to solve the liquidity problem. It is believed that major central banks, such as the Fed, ECB and BoJ, may find themselves forced to make up for the shortage of liquidity in the rest of the world even before providing the necessary liquidity to their respective countries and geographic areas.

Not only. As mentioned, the difficulties for emerging markets do not end with the need for liquidity. Other difficulties include a slowdown and disruption of incoming capital and a strong dependence of its economy on oil (between 2% and 15% of national GDP), at a time when black gold prices are extremely low.

Surrendered currencies and inflationary pressures

All of this can easily lead to significant currency depreciation, which has historically generated massive inflationary pressures, prompting the central banks of these countries to keep interest rates high and liquidity low in times of crisis – for example in 2007-2008. But this time the hunger for liquidity is too strong to imagine such a strategy.

If the drop in demand proves to be sufficiently pronounced to offset the inflationary pressures resulting from the depreciation of the currency, then there would be no problems for monetary policy. But presumably the drop in oil prices and capital outflows will last longer than the shock of demand.

So the task of the central banks of poor and emerging countries will be particularly difficult: they will have to be able to provide liquidity in the very short term, without compromising their mandate to keep inflation under control in the medium term.

If the situation seems difficult in the developed world, just think of emerging markets to realize that there are those who have more serious problems. And this time the crisis of the poorest economies cannot be labeled as a problem of others and thrown into oblivion: the problem, we have seen, concerns everyone.

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