Current account deficits in emerging market economies are expected to widen gradually this year, but they are not expected to become a systemic issue, barring severe drops in commodity prices, according to the Institute of International Finance.
Trade deficits in several emerging markets are below their pre-pandemic levels as favourable external balances were the flipside of deep recessions. Imports fell with domestic demand that shrank external deficits, the IIF said in its latest report on trade imbalances in 2022.
In the later stages of the pandemic-driven crisis, a rise in commodity prices lifted exports that more than offset the recovery in imports. Imports generally are exceeding pre-pandemic levels relative to gross domestic product, but strong exports are preventing imbalances, according to the IIF.
External balances currently look good in several countries, especially considering that 2019 was not a year of especially wide emerging market deficits.
“If commodity prices remain resilient, we expect manageable widening of EM current account deficits,” Sergi Lanau, IIF's deputy chief economist, said in the report, which was co-authored by the Washington-based institute's economist Jonathan Fortun. “We do not think external imbalances will grow enough in 2022 to make EM resemble the taper tantrum.”
Colombia is an exception among emerging economies where trade and current account deficits have widened ahead of the country’s elections that are marred by political uncertainties. Trade balance of Chile is also high given the trajectory of copper prices, IIF said, adding that on balance, it is “more concerned about Colombia” than Chile.
Trade deficit of India, Asia’s third-largest economy, is widening as well but “we do not expect the kind of critical imbalances we saw in the run-up to the taper tantrum”, it said.
The combination of a rising oil import bill and solid non-oil imports will likely widen India's current account deficit to around 2.5 per cent of the country’s GDP, “if Covid-19 does not cause further growth setbacks”, IIF economists added.
In Turkey, even though imports continued to increase in December, the IIF expects currency devaluation to shrink the trade deficit despite a domestic credit boom that will partially support domestic demand and imports.
Meanwhile, emerging market securities attracted capital flows worth $16.8 billion in December. However, foreign investment in emerging market stocks and bonds “outside China has come to an abrupt standstill” over fears that many economies will not recover quickly enough from the pandemic this year.
“We believe that the outlook is worsened by the Omicron variant and expectations of a stronger dollar and higher US interest rates,” the IIF said in its December Capital Flow Tracker report.
China, on the other hand, is sustaining the capital flow seen in the past few months, particularly in the last quarter of 2021 when investors pumped money into China equities.
“This China/non-China EM split is rooted on the growth outlook. Markets see China rebounding more quickly than other EMs,” the IIF said.
Inflation is also forcing the hand of policymakers across emerging market economies, with 15 of 20 major emerging market central banks tightening monetary policy since May. In December, non-China EM debt suffered an outflow of $9.6bn, while China debt saw an inflow of $10.1bn. December data also showed $16.3bn of equity inflows, mainly explained by the recovery of China equities that accounted for $12.5bn of the total.
“We see non-China EM in a de facto sudden stop. Underlying this overall picture is a lot of differentiation across individual emerging markets,” the IIF said.
“The latest Omicron variant, an acceleration of Fed tapering and stronger dollar carry additional risks for an already stressed EM flows picture going forward.”
