The Fed is performing one of the most aggressive tightening cycles in recent history. Historically, this has led to major financial distress in emerging markets, most notably the 2013 “taper tantrum”. Increasing capital inflows to the U.S. strengthens the dollar while the Fed’s tightening raises global interest rates, both raising financing costs for emerging markets that often lend in U.S. dollars. Record-high public debt levels and slowing growth are only worsening these problems. 

But there are other causes for concern: the growth of global trade and global value chains, sources of growth and innovation since the 1980s, is slowing because of general geopolitical risk and rising emphasis on self-sufficiency, e.g. for agricultural goods. Furthermore, inflation worldwide is exploding, driven by global supply-side disruptions and the Ukraine war. Inflation in basic goods, such as wheat and energy, often hurt emerging market consumers more, reducing aggregate demand. Lastly, the largest “emerging market”, China, is seeing economic headwinds due to its costly zero-Covid policy, attempts to deflate its real-estate bubble and general debt levels, and policy uncertainty over Chinese regulation of the private sector. This means China cannot be the fiscal and economic motor for emerging markets, a role that it has played in recent global economic downturns such as the 2008 financial crisis. All of this signals a risk-on environment for the emerging market universe. 

Burning questions

• Which emerging markets are best positioned to deal with rising interest rates and a stronger U.S. dollar? Probably those with low public sector debt, low external indebtedness and little debt denominated in foreign currencies, and liabilities with fixed interest rates. 
• Which emerging markets have the fiscal means to countercyclically boost their economies through these headwinds? Probably those with low public debt, who run small fiscal deficits, and have acquired sufficient reserves. 
• Which emerging markets could benefit from rising geopolitical uncertainty and risk? Probably low-cost economies with sufficient labor as production chains are relocated from China and Russia, or countries that are able to “triangulate” Chinese, Russian and Western/American interests.