VoxEU: Covid-19’s reality shock for emerging economies: Solutions to deal with dependence on external funding

The spread of Covid-19 to emerging economies has brought to light a reality that had been mostly forgotten in an era of ample dollar liquidity, namely, their excessive dependence on external financing. This dependence, which had been a long-standing problem, as exemplified by the large number of crises experienced in the emerging world since the 1970s, seemed to have been overcome. Covid-19 has brought to light a very different reality. Foreign investors have left these markets at an unprecedented speed, rushing to the safety of dollar assets. This resulted in a sudden global dollar shortage last March. The massive capital outflows from emerging economies are not irrational. Covid-19 is having a massively negative impact on emerging economies’ growth prospects, exports and fiscal accounts (Baldwin and Mauro 2020).

The sudden stop in portfolio flows into emerging economies has been unprecedented. In fact, the size of portfolio outflows is several times bigger than that of 2008, the 2013 Fed tantrum, or the China scare in 2015 (Figure 1). Against such backdrop, the IMF estimates that total gross financing needs of emerging markets could be as much as $2.5 trillion. This is very much in line with the IMF having received requests for financial assistance from as many as 100 members already. A good part of these needs is concentrated in a few systemic emerging markets which have long maintained market access and are suffering the most from the sudden stop in capital inflows. This is especially worrisome in countries with larger external debt to serve.

The full original article first appeared on VoxEU here.