Against all the odds at the start of his administration President Donald Trump has, up to this point at least, had a positive impact on emerging economies.
When Trump entered the White House in January, there were many reasons for large emerging markets to be anxious about the new administration. Analysts argued the president’s proposed tax cuts and increases in infrastructure spending would widen the US budget deficit and cause the domestic economy to overheat. This would force the Federal Reserve to tighten monetary policy to prevent inflation. This, in turn, would again attract capital to the US and strengthen the dollar.
Some emerging markets, especially China and Mexico, feared that the Trump administration would veer sharply towards highly protectionist trade policies, damaging their export-led economic growth. The president made many campaign promises to confront currency manipulators and tear up bilateral deals like the North American Free Trade Agreement which he feels disadvantage the US.
But Trump’s administration has failed to deliver on its economic agenda. The promised tax reform programme and infrastructure spending increases were postponed after a failed attempt to overhaul Obamacare. There are growing doubts about whether Trump has sufficient political capital to get a deeply divided Congress to adopt his budget proposals. And although the president has refused to subscribe to G20 countries’ pledge not to intensify trade protection, Washington has not branded Beijing a currency manipulator and Nafta is still in effect.
The consequence of Trump’s failure to advance his economic programme has been to delay further Fed interest rate increases. It has also undermined foreign investor confidence in the US economy, contributing to a weaker dollar. Since January 2017, in spite of heightened geopolitical tension that would normally support the dollar, the world’s reserve currency has lost more than 10% of its value.
Emerging markets welcome low US interest rates and a weak dollar. Low rates generally keep capital flowing to emerging markets, as investors are forced to stretch for yield abroad. A weak dollar usually boosts international commodity prices, a boon to commodity-dependent emerging economies.
But in a booming market, it can be difficult to distinguish between those economies with strong fundamentals, and those which merely look strong in the light of buoyant conditions. This explains why, in today’s environment of low interest rates and a weak dollar, emerging markets like Brazil, South Africa and Turkey can still access the global capital market on good terms, despite their unsound economic and political fundamentals. It also might explain why a country like Argentina can issue a century bond even though it has defaulted on its debts five times over the last 100 years. Or why war-torn Iraq’s bond placement in August was four-times over-subscribed.
Policy-makers in emerging markets are mistaken if they believe these favourable circumstances will continue indefinitely. They should take advantage of the opportunities that these conditions afford them to prepare for the difficult times that might lie ahead – the Fed is expected to raise rates in December, which may engender capital flowing from emerging markets back to the US. Policy-makers in these economies must address those fundamental weaknesses and imbalances that continue to make them all too vulnerable to any drop in global liquidity.
Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.