High dollar debt puts emerging markets at risk and how!

ET Intelligence group: A stronger dollar is reviving memories of a turmoil and stress that could be triggered by huge debt obligations of emerging markets. It’s no surprise that many global investors are no longer besotted by the EM universe.

The MSCI EM index — a gauge for global fund manager to benchmark their EM assets — and MSCI EM currency index have dropped below the crucial 200 daily moving average (DMA), an indicator used by traders to get a sense of the long-term trend.

A dip below the 200 DMA is typically perceived as bearish for any asset. The MSCI EM currency index is trading below the 200 DMA for the first time since January 2017. During this week, the swing in the EM currencies vis-à-vis the developed market units was the highest in more than two years.


The dollar-debt binge that EMs enjoyed in the past 10 years is beginning to hurt as servicing the greenback loans turn more expensive. EMs have to repay dollar debt worth $148 billion and $171 billion in 2018 and 2019, according to Bloomberg data. Bank of America-Merrill Lynch’s ‘global financial stress index’ has reached the highest level since February.

So far, investors have been selective in punishing EMs: the intensity of bearishness is higher in countries having weak governance and higher dollar debt as a percentage of GDP. The ones that look vulnerable are Turkey, Argentina, and Hungary. Turkish Lira depreciated 17% since the beginning of the year, and it has one of the highest trade deficits among G-20 countries. The other lot of vulnerable nations are those with high dependence on foreign bond investors – such as, South Africa, Indonesia and Russia. Markets like the Philippines and India are perceived as comparatively less risky.

Since the 2008 meltdown, the dollar debt borrowings by EMs nearly doubled to $8.25 trillion in 2017 from $4.47 trillion, according to Institute of International Finance – a reminder that few learnt from the Latin America debt fiasco, Asian financial crisis and Argentina default. The MSCI EM index wiped out 59% of its value after the Asian financial crisis in 1990.

Experts like the Harvard professor Carman Reinhart and Paul Krugman believe that EMs face a greater risk this time around.

Global brokerages are circulating notes to clients on how to cope with possible turmoil and build a ‘run for cover’ portfolio. CLSA has created a long-short portfolio for investors would have generated an average return of more than 6% a month during the past 10 major corrections.