Maritza Cabezas: What does Trumponomics mean for emerging markets?
This column was originally written in Dutch. This is an English translation.
By Maritza Cabezas
The new US administration has made it very clear that its involvement with the rest of the world will change. Recent global shocks and shifts, such as COVID-19 and the high interest rates of the major central banks, have proven relatively manageable for emerging market investors. But with current geopolitical and economic uncertainty on the rise, the question arises: will emerging markets come through this unscathed?
In the past, rising interest rates in the US were bad news for emerging markets because they led to capital outflows and financial instability. In recent years, however, these effects have weakened. When the US central banks' policy interest rates rose between 2021 and 2023, capital flows to emerging markets did not come to a standstill and no currency crisis ensued. Credible policies of central banks in emerging markets, flexible exchange rates and stronger international reserves contributed to this resilience. The situation improved further in the first half of 2024, when global inflationary pressures appeared to be under control. Investor sentiment towards emerging markets generally improved, boosted by expectations of interest rate cuts by major central banks, which would lower financing costs and strengthen local currencies against the US dollar.
However, this scenario did not fully materialize. The election of President Trump has led to the continued strength of the US economy and made the Federal Reserve more cautious about lowering interest rates. The announcement of US import tariffs soon followed, including a 25% tariff on aluminum and steel, an additional 10% on imports from China and threats of tariffs on countries that do not cooperate with the US government's deportation agenda. Although no one knows what the US government's next move will be, there has been no major disruption in emerging markets.
Potential and diversification
Emerging markets account for almost two-thirds of global growth and more than three-quarters of the world's population, demonstrating their strong potential. The number of investable emerging markets has doubled over the past 20 years, as has the diversity within this group of countries. Furthermore, some countries are rich in natural resources and are major suppliers of metals such as aluminum, copper, nickel and palladium. Many of these metals are crucial for the energy transition and, for obvious reasons, their production cannot easily be relocated.
Many emerging markets have gradually decoupled from the US. The economic ties between emerging markets have strengthened, especially with China, whose imports from these markets have quadrupled since 2000. China has been South America's most important trading partner for some time now, and Chinese tourists are flocking to emerging Asia. Finally, for some low-income countries with weak global trade relations, such as Pakistan and Guatemala, domestic factors are more important for their economic performance than the influence of American economic developments.
Still in need of foreign capital
Emerging markets, however, remain dependent on foreign financing and donor aid to develop their economies. Multilateral institutions such as the IMF and the World Bank offer financial support, especially in difficult times, on the condition that countries use these funds responsibly. That is how it has been for years. Until now.
The US and other donor countries have decided to tighten their belts and are resisting attempts to give multilateral institutions more clout. This means that financing will become more limited and financing costs will probably rise. China has already overtaken the World Bank as the most important lender to emerging countries, but its practices with regard to debt sustainability, working conditions and environmental care differ from those of other lenders. Private sector financing is more important than ever to close the gap that has arisen due to declining government funds and donor subsidies.
We cannot prevent the US from cutting its financial support to emerging markets, but we certainly do not have to follow suit. Emerging markets are now in a fundamentally better position; the capital outflow that usually leads to crises is not occurring. However, these countries need a stable source of financing in order to develop effectively. Financial inclusion contributes to this by investing in financial institutions in various countries, which in turn finance local small and medium-sized enterprises and thus help promote socioeconomic development.
We cannot give up on the progress made in recent years in the fight against extreme poverty and violent conflict and allow countries to fall back into a dark past. That is a future that no one wants to experience.
Maritza Cabezas is Investment Strategist at Triodos Investment Management
