"The risk of multiple economic and financial crises across emerging markets is now greater than at any time since the Asian Crisis of 1997-98, with the central and Eastern Europe region at most risk," said David Riley, global head of Sovereign Ratings at Fitch. "Several emerging market economies face outright recession, especially those with large current account deficits that international banks and markets are no longer willing or able to finance. Even for those with current account surpluses, capital outflows will add pressure to the balance of payments as non-sovereign borrowers struggle to refinance more than USD300bn of foreign borrowing maturing next year," added Mr Riley.
Despite the unprecedented scope and scale of intervention in support of banking systems in advanced economies, their banks' access to medium-term financing remains constrained and pressure to improve capital ratios and reduce risk intense. Consequently, the ability and willingness of "Western" banks to extend credit to emerging markets, whether directly or via subsidiaries, has fallen sharply. Foreign subsidiaries, like their parents banks, are under pressure to shrink their balance sheets, contributing to a domestic "credit crunch" and exacerbating balance of payments stresses. This process is adversely impacting nearly all emerging market economies, but especially in central and Eastern Europe where international banks have been the dominant source of external financing, and where the risk of country crises is greatest. Several sovereign ratings across the region have recently been downgraded and several remain on Negative Outlook. Though central and Eastern Europe is most at risk, risks are also on the rise elsewhere. In Latin America, countries with weak credit fundamentals that are reliant on commodity exports are especially vulnerable, while growth in the export-orientated Asian economies is now forecast by Fitch to slow to just 3% compared to 8% pa over the last five years. Nonetheless, sovereign credit fundamentals across emerging market regions are stronger than during previous episodes of crisis, reflected in reduced government borrowing from international capital markets in recent years and the accumulation of large stocks of foreign exchange reserves that provide a buffer against the current economic and financial turmoil.
Fitch has previously noted that emerging market sovereign creditworthiness is more directly at risk than in "advanced" economies because of the prevalence in the former of foreign currency denominated bank liabilities, currency mismatches in private sector balance sheets and monetary regimes anchored by exchange rate stability. Injections of local currency liquidity by EM central banks - a key pillar of sovereign support for the financial sector in advanced economies that benefit from "reserve" or "near-reserve currency" status - run the risk of triggering a currency crisis as investors and the public replenish foreign rather than local currency money balances, while sovereign guarantees of mostly foreign currency bank debt and deposits are less credible and more likely to be called.
Sovereign intervention in support of the financial sector in advanced economies has not however been costless. The gross fiscal cost is large - estimated by Fitch at around USD1.6 trillion, equivalent to almost 4% of aggregate GDP and much more in several countries, notably the US and UK - while cyclical and discretionary easing of fiscal policy in response to the deepening recession will lead to sharp deterioration in budget balances and rising public debt burden, though within the tolerances of existing ratings. While the financing risk faced by high-grade sovereigns is in Fitch's opinion low, structural deterioration in public finances, if not corrected by policy action, would undermine confidence in medium-term fiscal sustainability and hence sovereign creditworthiness and ratings.
