Are Weaker Economies on the Brink of Collapse?

The global economy is in a challenging state. After a tough few years with Coronavirus, it appeared that we had gotten through the worst of it – on the face at least. The stock market rebounded absurdly fast after the March 2020 crash, whilst most major economies only dipped into a technical recession briefly before recovering.

However, issues remained under the surface. Mostly within global supply, there were still shortages and logistics issues. Anybody chasing after the latest PlayStation 5 would have experienced this in full force. Today, we have even more severe supply issues with an energy crisis, made worse by the Russian invasion of Ukraine, which has caused sky-high inflation around the world. 

Ramifications on the weaker European economies

High demand-pull inflation is something that developing countries often experience as part and parcel of fast growth. This isn’t always a bad thing unless it gets out of hand. However, cost-push inflation, as currently being experienced, brings with it very little reward. 

When looking at who is experiencing the worst inflation in Europe, it is developing countries that top the list. Turkey and Moldova are in crisis, with 78% and 31% inflation respectively, whilst Ukraine, Belarus, Bulgaria, Romania, Macedonia, Bosnia, Kosovo, and Montenegro all have between 13% and 20% inflation.

It is arguably the weaker economies in the EU that are the cause of the ECB’s hesitation over raising interest rates. To still have negative interest rates in an EU that is currently suffering 8.6% inflation, does seem absurd. And although there are now plans of a slight increase, the reluctance to raise rates in alignment with the Fed’s is perhaps because the struggling economies would struggle to repay their debts – debts that were exacerbated over lockdowns.

As a result, the USD has reached parity with the Euro. Whilst the dollar is usually sought after during a crisis, the continuous rise in rates in the US is a huge factor in the weakening of currencies around the world. In fact, the Guardian has pointed out this is a selfish move by the US, in which dollar-denominated loans – which are common among developing countries – are becoming unsustainably expensive to repay.

It could be argued that the EU is merely anticipating a worse recession than the Fed, and so is reluctant to be heavy-handed with its contractionary monetary policy. Regardless, the weaker economies within the EU are seeing their purchasing power decline twice-fold: once through inflation, and again through a weaker currency. On top of this, they’re also seeing any dollar-denominated debts become rapidly more expensive.

Worldwide investors bet against emerging markets

As mentioned above, in turbulent times, the USD is often seen as a safe haven – unless it’s a US-centric crash, then gold is favoured. Emerging markets are a volatile asset class, so traditionally they’re avoided when a recession is on the horizon. MillionDollarJourney, among others, are not recommending emerging market ETFs for this reason.

In order to understand the other reason why investors are betting against emerging markets is to ask, who are the investors? Participants of the stock market have changed substantially over the past 5 years, with retail investors now playing an increasing role in total transactional volumes.

Well, it’s no surprise that western retail investors lack the time and knowledge to invest in emerging markets. For some, even the known risk of their own economies is more compelling to invest in than the unknown risks of an emerging economy.

If we look at a map of business cycles around the world, it seems that the only economies that are experiencing growth at the moment are emerging economies. Though, this isn’t the same as saying all emerging economies are experiencing growth – many are also at risk of a recession, along with the threat of devastating inflation figures. 

Deciphering through which emerging markets offer promising prospects and which simply carry too much risk is inherently difficult because emerging markets are in a unique moment unlike developed economies. This in and of itself is the risk that many are unwilling to take, not least on the bring of a global recession; the US dollar, commodities, and energy stocks just seems a safer bet right now.

Recessions hurt the poorest

We can get too caught up in talking about the stock market. But, in the event of a crisis, it hides the truth of what is going on underneath: mass redundancies, late wage payments, mortgage defaults, and small businesses folding. In moments like these, we realise why the Kenyan Shilling declining against the dollar is important.

It is the stock market activity that can turn an emerging market on its head, through shorting its currency (and thus artificially debasing its currency overnight) and pulling billions worth of investments out of the economy.

In general, it is the asset holders and investors that lose the least. They lose the most in terms of nominal value – a $20,000 decline in value of their stock portfolio – but they lose the least because they’re wealthy enough to have surplus assets. 

Holding onto assets until they rebound in value is possible unless your cashflow dries up, but clearly, it’s the poorest who are most vulnerable regarding cash flow. Those with poor job security and minimal disposable income will struggle to repay their increasingly expensive debt repayments.

Kenya’s position in the global economy

Kenya’s political and economic reforms are seeing the fruits of their labour right now. In the face of a global crisis, Kenya marches on with economic growth with an inflation rate in-line with the average developed European economy. Plus, some of that inflation is legitimately demand-pull.

Growth is expected to continue, albeit decelerated, into 2022 and 2023. The rise in fuel cost has expected impacts on inflation, though, and is hitting the poorest. Nobody knows the outcome of the 2022 election – or the impacts of global warming – just as we don’t know how the deceleration of the growth will impact foreign investment into Kenya. Very quickly, the cost of living could become more severe due to the depreciating Shilling, prolonged inflation, and investors becoming hesitant.