Emerging markets (EMs) are usually defined as economies with low to middle per capita income – hence they are usually countries with low liquidity, in need of Foreign Direct Investment (FDI). That is, they need capital to be injected both in capital markets and in the real economy in order to add volume to the country’s stock/bond market and to long-term investments in infrastructure. Additionally, their economies are driven by the production of either commodities or manufactured goods. Therefore two forces drive the EMs economic cycle: global liquidity and demand for commodities, which depend mainly on two economies. The first depends on the conditions of the American economy, the latter on how China is doing, given that China is the biggest consumer of commodities. It has been fueling the commodities bubble through its growth at record rates. A bust, also due to China’s slowdown, has followed: as an example iron ore has slid 22%, and copper is down 19% by the beginning of 2015.
China, among other emerging countries like Turkey, Mexico, India, Thailand, Greece and Hong Kong, are exporters of manufactured goods. However a difference must be noticed: while the first three countries are running their economies with a positive surplus, the last three countries have to deal with a negative surplus. This means that they are hurt severely as soon as capitals start to flow out.
This is what has been happening over the past months. In particular, over the past 13 months $1tn has been flowing out, causing concerns about the fact that emerging economies can lead the global growth. The outwards flow will probably accelerate because of concerns about the instability of China and as soon as there will be signs of a rate hike in the US. This will cause liquidity-dependent economies to suffer, causing their currencies to weaken further. Morgan Stanley recently changed the “Fragile 5” ranking to “Troubled 10”. Ten nations suffered particularly after the Yuan’s devaluation since China was their top export destination: these include the Russian Ruble, the Thai Baht and the Brazilian Real, that has been the one losing the most against the USD since August 2013, the 35%, demonstrating how Emerging countries are very exposed to global risks.
The People’s Bank of China (PBoC) recently intervened in the FX market three times in a row by devaluing its currency, causing the Yuan (CNY) to decline by 4.65%. This has consequences on Treasuries, deflation and purchasing power. In particular the devaluation of the Yuan will cause Chinese families and firms to have weaker purchasing power. Additionally, commodities, whose price is generally denominated in US Dollars (USD), will be more expensive causing a stronger downward pressure on their prices and therefore on commodities exporters like Brazil, Argentina, Indonesia, United Arab Emirates, Kuwait and Qatar. Here too a difference has to be underlined: while the first three are running economies in deficit and the last three have a surplus. Countries like the first three are essentially exporting agricultural and mineral products, which prices have been falling in the past weeks. In particular the share price of many mining companies has collapsed. Their growth has been pushed by financing wide deficits that will deepen because of current global conditions: their economies will experience crises and, for example, deindustrialisation as seen in Brazil. The last three have economies essentially based on export of oil, but since they run surpluses they are less subject to the global liquidity cycle.
Overall imports from EMs in June, were 13% lower YoY, according to Capital Economics. This demonstrates how outwards liquidity flows and lower commodity prices have caused lower income in countries which economies are based on the export of commodities. In this moment investors are getting rid of EM currencies as faster as they can: think about the Turkish Lira (TRY), which dropped in the past days hitting a record low against the USD equal to 3$. As a result of the drops, JPMorgan’s EM Currency Index has declined by 2.4% this month, hitting its lowest since the 2000.
Why should investors put money in these countries given their instability? Emerging markets can be defined as assets tied to economies of risky countries. The appeal of the emerging markets is given by the fact of being risky – therefore investments in those countries have to embed a risk premium, very attractive in periods in which rates are very low. Risks can be given by geopolitical threats, impaired creditworthiness as reflected by speculative grades because of systematic defaults like in the case of Argentina and a non-democratic regime that might impede the creation of reliable capital markets based on contracts which are supported by a sound legal system. Another advantage is given by the diversification of a portfolio, allowing to eliminate or at least reduce the idiosyncratic risk. Therefore investments in emerging markets are attractive for their ability to diversify while adding risk to the portfolio.
Venezuelan Digital Currency Backed by Oil
Venezuela has announced plans to launch a digital currency, “the petro”, backed by the country’s oil and mineral reserves. The petro aims to help ease the country’s monetary crisis but sceptics claim the proposal has no credibility and will not help those in extreme need.
Why It’s Important
Hyperinflation has eroded the Venezuelan bolivia’s value by 97% this year, making imports incredibly expensive and causing many to abandon trust in the currency. The country’s oil reserves made up 95% of its exports in 2016, while oil and gas extraction accounted for 25% of GDP. Rich supplies of resources provide some initial credibility to the proposal, but President Maduro’s questionable track record when it comes to monetary policy is making many sceptical about the proposal. His currency controls and money printing have only added to the monetary crisis. Maduro has not announced when the digital currency would come into use or any details regarding how the country would create such a system.
Opposition leaders argue the country’s shortages of food and medication are far more pressing and that the digital currency will not address this. The digital currency may provide a more trusted medium of exchange, but it is unlikely to help those in excessive poverty.
Venezuela’s Inflation Is at 4000%. Here’s Why
Venezuela’s currency, the bolivar, has lost 96% of its value this year. As the currency becomes near worthless, imported food and medicine are in short supply. A humanitarian crisis is unfolding.
The government and state-owned oil company, PDVSA, owe bondholders $60bn alone and have recently defaulted on debt repayments. More defaults could mean investors seizing their stake in Venezuela’s oil.
Why Is Venezuela in Debt?
Acting upon the country endowment of natural resources made it an economic success in the mid-2000s.
Yet, while the price of oil skyrocketed during the late-2000s, former President Hugo Chávez matched this with Venezuelan public debt.
Once the price of oil dived in June 2008, lenders stopped extending credit to the country.
Defaults on government bonds are largely to blame for this inflation.
In 2016, OPEC found that oil reserves accounted for 95% of the country’s exports, while the oil and gas extraction combined made up 25% of its GDP.
Venezuela’s overdependence on oil and lack of saving during its heyday are the leading causes of the current crisis.
The Psychology Behind Saving
The idea that the poor do not save enough money just because they are simply “too poor to save” is wrong.
Gambian farmers have in the past saved in cash (wooden lockboxes with savings were smashed open in an emergency or once the savings goal was reached), stored crops, and consumer durables. Saving in livestock and jewellery enabled other farmers to convert cash into less liquid assets to prevent unwarranted and frivolous spending. A detailed household survey conducted in 13 countries found that for many people in the developing world saving may be counter-intuitive. The poor and the extremely poor, those living on less than $2 a day and on less than $1 a day, respectively, do have a significant amount of choice in regards how to spend their money.
The Developing World
The poor do not use all of their income to buy calories, but only allocate between 56% to 78% to food. Spending on tobacco and alcohol (considered non-essential and nonfood items), and festivals (weddings, funerals or religious events) plays a significant role in household budgeting. For example, the poor in rural areas of Mexico spent slightly less than half the budget on food, and 8.1% on alcohol and cigarettes. The poor and the extremely poor spend about the same on food, which suggests that the extremely poor feel no extra compulsion to purchase more calories. Instead, the remaining income is often saved across a variety of informal saving groups, including peer-to-peer banking and peer-to-peer lending.
It is often the poor, women and the rural communities who are the least banked (those without an access to formal banking services). Not surprisingly, without an access to savings accounts or other formal financial services, it is difficult for families to manage unexpected risks, like illnesses, or plan children’s education. But the desire to save and engage with financial services is still there, as shown by a large uptake in the savings plans in Kenya despite high-interest costs, high withdrawal fees, and close to negative interest rates.
Yet, inchoate financial infrastructure in the developing world cannot on its own explain undersaving. Behavioural economists argue that the poor are no different to the rich in their saving habits: both groups are subject to cognitive biases and inherent human irrationalities and face self-control problems. When it comes to saving, “present bias” (or procrastination, proverbially) occurs when people give stronger weight/preference to an earlier option or purchase that provides instant gratification, rather than setting some funds aside for emergency use. Due to income uncertainties, however, the consequences of this “live for today” behaviour are far more detrimental to the poor than on the rich.
The Developed World
Undersaving is not exclusive to the developing world. Household saving rates, the difference between disposable income and consumption, vary greatly across the world. In 2017, Switzerland and Luxembourg, closely followed by Sweden, are the three countries with the highest savings rates. However, a higher GDP per capita does not necessarily equate to a higher savings rate.
In other words, people with higher income in the developed world countries do not always save more. Consider the US with GDP per capita $57,466 and savings rate of 5.3% and the Czech Republic, GDP per capita $35,127 and a savings rate of 6.7%. Similarly, with GDP per capita of over $43,000, the UK’s household savings rate was 3.3% in 2016, the lowest level since 1963, while in Hungary ($27,008 GDP per capita) the savings rate has been on average 4.5% in the past three years.
Is it possible to fully comprehend the monetary hurdles of low-income families? Undoubtedly, consuming today might be a rational choice and a necessity to survive. But, biases deserve context. For many in the developing world saving at home still remains hard. Technological innovation in finance and growth of electronic wallets have already alleviated some of the hurdles of saving money, but technology is not the silver bullet that will address undersaving. An active and conscious commitment to saving and awareness of biases could have a strong beneficial impact on the lives of the poor.
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