Liquidity crisis in EM, Currency Devaluations and

Consumption
By: Amit Bhushan
2016

Date: 20th Jan

The liquidity crisis in most emerging markets with pull out foreign funds (read
USD), is accentuating the collapse of capital markets in EM and also reducing
avenues of borrowing for the local firms of most emerging markets. Partly, its on
account of the markets own behaviour and key players (viz. Central Banks)
reluctance - to build further reserves/accumulation of currencies that are likely to
depreciate, say on account of quantitative easing or otherwise viz. Euro/ JPY or
RMB in the given scenario. This is because the held reserve is still required to be
reported in effective dollar value and a depreciation in effective value is likely to
sound as loss on their books. Same thing is true for corporates who report
financials is either local currency or USD. This is leading to a glut in commodities,
especially where storage is challenge or where consumption in significantly
down/showing de-growth/ reduced growth. For food commodities with relatively
in-elastic demand at global levels, the governments (in emerging as well as
developed) need to ensure cheaper food for the poor/under-employed and
unemployed and therefore even with currency depreciation, they need to ensure
manageable prices and so a fall in effective USD terms.
To get out of the situation, the word needs rising wages as well as rising
consumption - at places where it can easily happen which is basically emerging
markets, where there is a sustainable demand basis need and paying capacity.
The paying capacity might be questioned but the emerging markets have shown
a relatively better ICOR (incremental Capital Output Ratio) i.e. if output is
measured in quantity of goods produced & sold rather than currency value
terms. The ability to service capital in absolute terms is also intact for most
emerging markets in such scenarios. It is focus on this section that would help
build up the consumption base and employment/wages. Usually the paying
capacity is measured in value of widgets derived in easily convertible currencies
and this creates a halo while what is only needed is return on capital
employed in convertible currencies (as far as economic value is concerned).
While this is true for investment perspective, though most corporates still use
trading perspective in mind even while making investment decisions. This
remains the case even when trade is going down while countries are increasingly
seeking investments to ramp up domestic production and jobs. The EM in
question will have to achieve cost structures whereby which some its produce
can be exported in order to repay the Fx inflow.
However what we are witness to is reverse i.e. such markets say for example
China or others, where currency is falling and the wages either stagnant or
falling. The lack of Chinese corporates to push invoicing in RMB as well as their
imports in RMB as well is part of the problem. Easier loans in RMB to emerging
market entities in such a scenario might help to internationalize RMB and allow
Chinese businesses to expand. Such a push and getting market acceptance for
the practice could internationalize RMB more, however given geopolitics in South
East Asia and beyond, this has not really taken off to the extent that could have

mitigated the problem to some extent by helping RMB reserves to grow (Not sure
what the response of such institutions would be in case US were to again go for
Quantitative easing). An inflow of say RMB 1 trillion (approx.. USD 200 billion) in
next 3 years in mix of investment and credit might be enough to support key RM
countries to tide over the Fx upheaval in the volatile ongoing scenario. Lack of
open markets and transparency for free trade in the currency may also be part of
the problem. It is also true that the other emerging markets also tend to reposition their currency basis competitive situation for exports rather than
sustaining domestic production & consumption. Its often peculiar because these
countries need to maintain their creditworthiness as well as protect accumulated
reserves position from erosion as a priority rather than manage domestic
demand alone. Thus external factors weigh in such situation much more than
internal balancing position since the rulers are scared of possibility of capital
flight and irrational exuberance amongst masses, taking over. Past experience
has shown that such speculative behaviour has long term repercussion and thus
become urgent rather than important with governments spending
considerable time in fighting these issues which keep recurring every few years.
Sorting out these issues may impact global opportunity spectrum in manner
which may not be in line with the expectation of current stakeholders. These may
be within the emerging economies who tend to profit from such turmoil and may
have stake in the un-balance in the global economic opportunity spectrum to
remain as it is. A fundamental alteration in the established mechanisms with
unknown mechanism is not desired by many, in any case. This allows time for
some of the more developed counterparts to get their act together, in the view
that the emerging markets perhaps are much more disturbed. The sustainability
of demand in these markets may be a challenge given the relative cost
structures of their produce and its competitiveness in the international markets.
Although this may take a bit longer time to re-establish, as is the case. In the
meantime the emerging countries may need to continue to re-adjust basis
external situation and try working out swap arrangements with key trade
partners who may be willing to lend a helping hand or where interests collude, so
that they can maintain consumption and jobs in the domestic arena, though
effort may be made to minimize competitive devaluation which is likely to hit
almost all emerging markets much more severely than otherwise.