Market confidence in emerging markets improved this week in the wake of rescue packages for Ukraine and Hungary combined with the historic announcement of a short-term liquidity facility for developing economies from the US Federal Reserve and the International Monetary Fund.
With abundant resources, in principle, available to address liquidity runs on the short-term debt liabilities for emerging market companies and sovereigns, this decisive action has raised hopes that asset prices will rebound. "This provision to provide virtually limitless capital quickly without red tape interfering and whenever markets plummet should seriously boost market confidence," said Blaise Antin, head of research for the $1.9bn TCW Emerging Market Fixed Income Fund in Los Angeles.
On Wednesday, the Federal Reserve agreed to provide $30bn of direct currency swap lines to each central bank in Brazil, Mexico, South Korea and Singapore as dollar funding has all but dried up. This arrangement is effective until April 30.
The announcement coincided with the IMF’s unveiling of a short-term liquidity facility to stem the financial contagion. The facility will increase the borrowing limits for emerging market countries from three times their quota (financial contribution) to five.
Unlike traditional IMF arrangements, there are no conditions attached to accessing the facility other than a good track record in fiscal and monetary policies. This excludes economic outliers such as Argentina and Venezuela and most likely, large current account deficit nations such as Turkey and South Africa, analysts say. IMF officials said the three-month funds could be made available within three days.
The measures this week could go some way to inducing market confidence. As Emerging Markets was going to press, South Korea’s benchmark stock index surged a record 12%, the won jumped 14% while interbank lending rates around the world fell.
In addition, JP Morgan’s EMBI+ index narrowed by 61bp to 721bp over US Treasuries. "We have really seen an improvement in market tone this week and some liquidity is coming back now that governments and supranational bodies are doing all they should and can do," said Ian McCall, director of Argo Capital in London.
The agreement to provide balance of payment support programmes for Ukraine, Hungary, Iceland and Belarus via the IMF will help to address structural crises in emerging markets. The IMF and Fed swap facilities, however, are designed to shore up short term liquidity in countries that have been held hostage by the global shortage of dollar funding.
"This facility, along with the large amounts of cash given to Hungary and Ukraine, is a shock and awe strategy since giving a lot of money to small economies and providing cheap dollars will help stem the contagion resulting from any emerging market failures," said Antin.
Soaring demand
As investors deleverage, demand for dollars has skyrocketed, causing emerging currencies to weaken. This has raised the spectre of a run on central bank reserves in some countries as regional currencies plummet and the inability to roll over debt heaps on contingent liabilities for sovereigns.
In a bid to ensure clear liquid support for emerging markets without revealing the extent of their liabilities, countries will be able to access the new IMF facility confidentially in contrast to the so-called "contingent credit line" established by the IMF in the wake of the Asian financial crisis. But some observers say that with around $250bn in the global policy lender’s arsenal before the latest emerging market sovereign bailouts, there is little capital to address the short term dollar financing needs of emerging markets.
But Antin at TCW was confident that given the unprecedented international co-ordination in recent months, countries with huge foreign-exchange reserves such as China, Japan and the Gulf region would muster the resources to stave off banking crises in systemically important emerging economies. With more buyers than sellers and chronic risk aversion, emerging market assets have been routed by the global credit crash over the past month, effectively overshooting fair value levels. The hope is that this week’s confidence inducing measures will breathe life into secondary markets.
In addition, there has been little real money trading in cash bonds, highlighting the stubborn lack of liquidity available as financiers deleverage. As a result, the "door for the external bond market remains firmly shut until the liquidity crisis is over," said one emerging markets bond syndicate head in London.
Nevertheless, "there has been such a large number of positive announcements this week, it will take some time for the market to analyse this and react." Ultimately, the price action for bonds and equities is likely to continue downwards as market participants focus on the second stage of the global crisis: recession in developed economies.