Developing countries stymied by rising interest rates and COVID

Published : September 04, 2021 16:28 IST

The COVID-19 crisis has made it clear that the once celebrated BRICS countries hardly have anything in common anymore. Photo: Reuters

Emerging markets like the BRICS countries have been hit hard by the coronavirus pandemic. How quickly they recover depends not only on vaccination rates, but also on the U.S. Federal Reserve.

The more a country is intertwined with the global economy — whether through industry, trade or tourism — the greater the potential damage from the COVID-19 pandemic. Germany and other rich countries have tried to mitigate this damage with the help of huge aid and economic stimulus packages.   

But emerging economies worldwide are mostly not in a position to mobilize the same amount of resources. "They lack the resources," said Klaus-Jürgen Gern, an expert on business cycles and growth at the Kiel Institute for the World Economy (IfW). "Measured against overall economic output, their government revenues are usually lower. They also cannot borrow on the international capital markets to the same extent as the industrialized countries."

Fear is on the rise

As the COVID-19 pandemic spread in spring 2020, many feared a major economic catastrophe. But it has so far failed to materialize. At that time, investors withdrew their capital from emerging markets at record speed, threatening to bleed the countries dry financially. But after the initial shock, the situation returned to normal.

Global financial institutions like the International Monetary Fund (IMF) and the World Bank have provided a lot of money and played an important role in stabilizing the markets. "In this way, they allayed investors' fears that sovereign bankruptcies could occur as a result of the crisis," Gern told DW.

In the meantime, however, fear is once again on the rise. As inflation increases in the United States, the Federal Reserve could raise its interest rates in the foreseeable future. "For emerging markets, there is then a risk of a sharp rise in the cost of capital and a flight of capital," Clemens Fuest, head of the Munich-based Ifo Institute, told DW.

Interest rate concerns

This has already been witnessed several times in the years following the 2007-08 financial crisis, for example in 2012-13 or 2015-16. When capital is withdrawn from emerging markets, it causes their currencies to crash and there is a lack of money for investment.

Overall, however, these risks are lower today than in the past, partly because emerging markets now have more experience in dealing with the problem, said Fuest.

Nevertheless, IfW researcher Gern points out that emerging economies have "dramatically increased" their debt over the past decade. "Before the 2007-08 financial crisis, emerging markets' public debt averaged about 30 per cent of economic output. Now it's closer to 65 per cent," he said.

So, as interest rates rise, an ever increasing share of government revenues must be used to pay back the debt.

Some emerging market economies are already facing severe problems. The Argentine peso, for example, has lost around a third of its value against the U.S. dollar since the start of the pandemic, and inflation is running at around 50 per cent.

A big minus

The economies of major emerging markets such as India, Mexico and South Africa also contracted by around 7-8 per cent in 2020. Unlike in the past, most of these countries were unable to decouple themselves from the global trend and failed to act as growth engines. According to IMF estimates, the economic slump in emerging economies excluding China was even greater than in the industrialized countries.

The crisis has also shown that the once celebrated group of BRICS countries (Brazil, Russia, India, China and South Africa) hardly has anything in common anymore. Of the group, only the Chinese economy was able to grow last year.

In Russia, the economy was down 3 per cent, while in Brazil a 4 per cent decline was compounded by high infection and death rates due to COVID and a populist president, Jair Bolsonaro, who is putting the country's democratic institutions under pressure.

BRICS' star fades

Next year, the IMF estimates the Brazilian economy will grow by less than 2 per cent. It is a devastating figure for a country once seen to be on the threshold of becoming an industrialized nation.

A lack of political stability and often a lack of legal certainty are the reasons why the BRICS' star has faded, Michael Hüther, head of the Institute of the German Economy (IW), told the Handelsblatt newspaper. The days "when all you had to do was shout BRIC and investors jumped" are over, he said.

The forecast is similar for South Africa whose problems have been compounded by political unrest and severe lockdowns. "South Africa is deeply integrated into global value chains and thus its economy is vulnerable in the same way European economies are," said Christoph Kannengiesser, head of the German African Business Association.

Nevertheless, for German companies operating in the country, there is no reason to withdraw, the expert stressed. "German industry, which is heavily invested there, is committed to South Africa as a business location and is basically optimistic," Kannengiesser told DW.

Recovery depends on vaccines

How quickly these economies can recover depends on the authorities' ability to control the COVID health crisis. But because of a lack of vaccines, inoculation rates in Africa have so far been extremely low, while at the same time the U.S. and the E.U. are mulling over booster vaccines for their populations. Kannengiesser believes there's no point in discussing whether this is fair.

Rather, he said, the aim must be to make the African continent less dependent on aid from others. "Africa must be put in a position where it can produce the vaccines it needs by itself. This is not a question of patents, but of production capacities."

However, boosting production capacity cannot happen overnight. In the meantime, Germany should consider donating surplus vaccines not only through the international COVAX initiative, but also bilaterally, the expert underlined, adding that COVAX has faced great difficulties in quickly supplying vaccines to countries that need them urgently.

This article was translated from German.

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