Strategy Note / Global

Geopolitics after Covid-19: US-China cold war, fragmented EU and GCC

  • The effects of the global demand shock likely outlast the shock itself, risking reform and regional coordination
  • Regional blocs, with incomplete integration, will fragment even quicker (EU, NATO, GCC)
  • US-China friction will shift to a fuller Cold War, dividing the world into two camps instead of renewing globalisation
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In our latest look at the impact of the economic shock brought on by Covid-19, we focus on geopolitics. We think there will be long-lasting negative effects on regime stability, structural reform and relations with neighbours.

In the same way that hysteresis (the impact of shocks far outlasting the duration of those shocks) can impact individuals or segments of an individual economy, it can impact entire countries or blocs of countries. The effects of the global demand shock will likely outlast the shock itself:

Commodity exporters will see greater risks to government stability, particularly where citizen welfare expectations are high, such as in the GCC (where fiscal breakeven oil prices are far above current levels), political legitimacy was already at risk (eg Algeria, Iraq, Iran, Peru), or where Covid-19 responses are particularly poor (eg Brazil, Iran).

Countries in the midst – or in urgent need – of structural reform, likely find it politically much more difficult to implement this reform in a much tougher economic environment (eg France in developed markets, Brazil, India, Saudi, South Africa in the large emerging markets, or Argentina, Egypt, Indonesia, Pakistan, Philippines in smaller emerging markets).

It is possible, of course, that the current crisis may prompt some countries which have been reluctant to pursue structural reform historically to change course. There is no sign of this yet and there likely needs to be much more pain felt before the deep-seated vested interests, which have inhibited reform historically, acquiesce, eg Bangladesh, Indonesia, Nigeria, Thailand, or Zimbabwe could all be candidates for this.

In the same way that inequality is likely to increase between individuals within one country (the regressive impact of the economic shock), it is also likely to increase between countries in the same region. The results are also analogous: more spillover of insecurity, migration, strain on bilateral relations, appeal of nationalist politicians. Note the initially scornful response to the Covid-19 outbreak in Iran by some of its neighbours (and the US) and the subsequent blame directed at Iran when infections spread to those neighbouring countries, or the use of Covid-19 as a pretext for populist politicians in Europe to reinforce their message on refugees and immigration.

Figure 1: Human Capital Index Rank in EM with over 40m population

Source: WB, Tellimer Research

Figure 2Human Development Index Rank (1 = top globally out of 190 countries)

Source: UN, WB, Tellimer Research

Regional blocs, with incomplete integration, will fragment even quicker (EU, NATO, GCC)

Prior to the current crisis, strains were already evident in regional blocs and security alliances, such as the EU, NATO, and the GCC. (In this context, organisations like the African Union, ASEAN, or Mercosur should not be included, because they have hardly acted as coordinated, credible geopolitical actors in the past).

The absence of coordinated responses to Covid-19, in part because these blocs and alliances were not designed for cooperation during crisis so much as for cooperation during more orderly environments, may push some of these alliances towards breaking point.

  • The EU was already struggling with the repercussion of the sovereign debt crisis (which dates back to 2009), Brexit negotiations, and the rise of authoritarian governments (eg Hungary, Poland, and, for a while, Romania). The perception that the EU (specifically its relatively richer northern states) has failed to provide urgent and adequate assistance to its struggling states is in plain sight in the rhetoric of political leaders in Italy and Serbia. Furthermore, the democratic norms included as a part of EU membership criteria were already under strain with the authoritarian shifts in Hungary and Poland (as well, for a while, Romania); these strains are likely to increase as some leaders impose and hold on to emergency executive powers for an indefinite period.
  • NATO was already divided over issues such as allocation of defence budget needs, Iran, the Sahel region of Africa, and Turkey (in terms of its Russian arms purchases and incursion in Syria). Spillover of Covid-19 infection-related disruption in Syria to Turkey, or regime destabilisation in Iran because of US sanctions which inhibit the Covid-19 response, could test the coherence of the alliance.
  • The GCC was already divided internally on the issue of Qatar and its relations with the Muslim Brotherhood, Turkey and Iran. In the early days of Covid-19, intra-regional travel was restricted but on a unilateral and ad hoc, rather coordinated and systematic, manner. In the event that the crisis brought about by Covid-19 and, more importantly, the oil war, puts intolerable strain on Oman (with its stretched sovereign balance sheet and high fiscal breakeven oil price, relative to other GCC members) from a social or currency perspective, it is not clear whether the richer GCC members will repeat the sort of assistance they provided after the “Arab Spring” in 2011-12.

The fragmentation of these blocs and alliances has major repercussions for the emerging markets, more widely.

  • Further exits from the EU would reduce the utility of the EU trade deals negotiated by emerging market exporters and, more importantly, pit nearby emerging market exporters against competition from those exiting (eg Egypt, Morocco, and Romania might have to compete with an Italy or Spain which has exited the EU and effectively devalued its currency).
  • Strains which saw Turkey exit NATO or Oman exit the GCC would allow for geopolitical rivals to the US and the EU, eg China, Russia or Iran, to expand their influence in these countries.

US-China friction will shift to a fuller-blown Cold War, dividing the world into two camps

The international Covid-19 response, both in healthcare protocol and economic stimulus terms, has been uncoordinated, at best, and characterised by suspicion and beggar-thy-neighbour, at worst. Given the scale of the disruption, it is unlikely that globalisation (or de-globalisation) continues the same trajectory that preceded the crisis.

Logically, there are two outcomes. Either there is a reversal of de-globalisation politics and a move to more coordination, strengthening of international bodies, and assertion of superpower leadership. Alternatively, the opposite occurs and there is acceleration towards isolationism and tribalism in international relations. A scenario positioned between these theoretical extremes may already be playing out: a more formalised cold war between the US and China.

Prior to the current crisis the US and China were already on opposing sides on many issues, for example:

  • Trade access (tariffs, intellectual property protection), with the Phase 1 deal representing an incomplete and fragile agreement;
  • Technology in 5G mobile networks;
  • Territorial control in the South China Sea (from Vietnam to the Philippines);
  • Belt and Road Initiative (BRI);
  • Iran;
  • North Korea;
  • India-Pakistan;
  • Hong Kong;
  • Taiwan;
  • Uighur Muslims;

Control and influence in a range of existing international bodies and agreements (eg UN, IMF, WB, WHO, WTO, IAEA, FATF) and the early stages of establishing rivals to these by China (eg AIIB in infrastructure finance, RCEP for regional trade).

The reactions on both sides to Covid-19 point in this direction, eg

  • China’s triumphalist rhetoric on arresting the rise of reported infections (almost as a means to demonstrate the credibility of its flat-lining of infections);
  • China’s very public show of sending doctors and medical equipment to the likes of Italy or Spain;
  • The Trump administration’s pointed referral to the “Wuhan” or “Chinese” virus long after other political leaders or mainstream media had stopped using these terms;
  • Hints from the Trump administration that China withheld timely information at the time of the Covid-19 outbreak; and
  • Tit-for-tat effective expulsions of journalists.

The challenge for emerging and frontier market investors in a US-China cold war scenario will be to identify the countries able to occupy what might be a very narrow geopolitical space:

  • Feed China’s consumption base directly with finished goods or (indirectly) with commodities;
  • Benefit from China’s export of capital (BRI-type infrastructure investment deals with governments, as well as foreign direct investment into corporates);
  • Benefit from US trade barriers on China which drives relocation of manufacturing to rival locations; and
  • Avoid falling offside of US interests and risk the penalty of trade barriers and sanctions.


Figure 3: Voting rights in multilateral financial institutions

Source: Tellimer Research

Figure 4: China and US non-diplomacy

Source: Twitter (@realDonaldTrump, @zlj517, Lijian Zhao, China MFA)



Figure 5: Defence spending (US$bn, 2019), the US dwarfs all others

Source: IISS, Tellimer Research. Includes procurement, R&D, maintenance.


Figure 6: US versus China defence spending (US$bn), China has stopped narrowing the huge gap in the past 3 years

Source: IISS, Tellimer Research. Includes procurement, R&D, maintenance.

You can read more on how Covid-19 is reshaping the world in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.

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Strategy Note / Global

Business models after Covid-19: Accelerating the next industrial revolution

  • A wholesale relocation of supply chains is impractical and unlikely
  • The adoption of new technology in services will accelerate, hastening decline of “analogue” services
  • Tourism and travel: leisure may survive better than business travel, emerging markets better than developed
Hasnain Malik @ Tellimer Research
16 April 2020
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In our latest look at the impact of the economic shock brought on by Covid-19, we focus on business models. We think the adoption of automation in manufacturing will accelerate, and stockpiling for corporate and national security purposes will be given greater priority, but a wholesale relocation of supply chains is impractical and unlikely.

There are several reasons why wholesale relocation of manufacturing away from China or full repatriation on an entire vertical chain of manufacturing back to home markets, even ones the size of the US, are unlikely.

  • While reliance on manufacturing located in China has exposed a vulnerability in all supply chains, the relocation of that manufacturing back to a home country large enough to potentially host it (eg the US) would not any better guarantee the availability of product during a truly global pandemic.
  • The diversification of production away from China was already underway (hence the growth in manufacturing across South Asian countries like Vietnam and Bangladesh, and, even, in East Africa in recent years) – it is just that this was being driven mainly by cheaper labour, efficient enough infrastructure, and, more recently, more favourable export tariffs.
  • Many richer countries may no longer have the environmental appetite, or economically viable supply of intermediary inputs in sufficient quantities to support the complete repatriation of manufacturing – this could apply to the UK as much as it does to Qatar.
  • Some countries, both developed and emerging, may be too small – in terms of population, space, and financial capital – to establish manufacturing on a scale to shift away from dependence on China.
  • The shift of a complete vertical manufacturing supply chain means that raw materials and intermediate inputs are required, as well as assembly, and this compounds all the factors listed above.
  • Unless the world shifts entirely to a state-driven model of production, then privately-owned companies will remain the owners of manufacturing production. Private companies will continue to maximise shareholder return and likely resist the relocation of manufacturing unless the state completely skews regulation (through business licencing, tax regimes, and subsidies) and forces more expensive product onto its population of consumers.
  • Self-sufficiency in manufacturing is an illusion. Just ask those who crafted the Saudi national strategy in the 1970s to establish food security, of which self-sufficiency, enabled by the deployment of technical exports and huge fiscal resources, was one component. This ended up delivering, by the 1990s, too much overpriced wheat, for example, and a massive depletion of water resources. Saudi ultimately shifted to a strategy of purchases of overseas land spanning, for example, Australia, the Philippines, South Africa, the US, and Argentina).
  • As a way of repatriating manufacturing (of potentially anything, apart from food), the adoption of 3D-printing may alleviate some of these challenges (eg supply of labour, some raw materials and intermediary inputs) but only where 3D-printed products are durable enough (and we are still very early in the evolution of 3D-printed products for the mass market) and only for countries with sufficient indigenous supply of electric power and petrochemicals.


Figure 1: Global manufacturing share – China is 28%

UN, Tellimer Research

The adoption of automation in manufacturing will accelerate but within limits

While entire manufacturing chains are unlikely to relocate, within existing manufacturing facilities the embrace of automation technologies is likely to occur more rapidly.

Still, there are obvious limits to this: individual companies will only adopt automation when the probability-weighted costs of human indisposal (eg in the event of an epidemic) outweigh the present value of the fixed costs of new machinery, and there are some manufacturing processes involving human input that automation is still a long way from solving (eg manipulating and twisting fabric for stitching complex garments).


Figure 2: Industrial robot installations

Source: International Federation of Robotics, Tellimer Research

Figure 3: Robot density

Source: IFR, Tellimer Research

Figure 4: Installations of robots by industry (2018)

Source: IFR, Tellimer Research


Stockpiling for corporate and national security purposes will increase

While the complete repatriation of manufacturing is not feasible, greater stockpiling – for both corporate inventory risk management and, for essential items, government security risk management – is inevitable. The end result is higher cost for consumers.

The adoption of new technology in services will accelerate, as will the decline of “analogue” services (e.g. traditional retail, banking)

It is an almost universally consensus view, reflected in the outperformance of technology, and in some cases, telecom, equities throughout the crisis, that the delivery of services based on human capital and, traditionally, physical meetings, will shift even more rapidly than it already was to internet-based platforms: eg healthcare, retail, education, finance, and entertainment. In emerging markets, the most widespread instance of this is in the more rapid adoption of online payments and transfers.

While technology companies benefit, with perhaps a few years’ worth of technology adoption gains within the space of a few months, traditional retail, advertising, entertainment (sports, music), real estate companies and banks exposed to increasingly stranded retail and commercial assets suffer.

A few caveats that should be mentioned in this regard:

  • After such a prolonged period of social isolation there may be a backlash in favour of a return to the “bricks and mortar”, face-to-face, analogue, “real-life” version of all these services. At the extreme, for white collar workers, dressing up and working from the office might become every bit as much of a privilege as dressing down and working from home once was.
  • Technology’s gain should not always be mistaken for gains for the entire “sharing business model” and “gig worker” economy. The owner of the underlying asset might maximise utilisation in good economic times but in bad times they may be every bit as exposed to the fixed costs associated with that asset. Furthermore, this crisis has brought home one truth for asset owners in the sharing business model: the flexibility so cherished by home or car owners, or gig workers, in good times has been matched with the horror of near zero protection of income in a downturn.
  • The unexpected windfall of technology application users likely, in the short-term, does not drive higher revenues for technology companies, because most of them will be under, at least, soft pressure from governments not to charge fees for services (and may have been encouraged to cut fees to existing users) which have become mission-critical for most of an economy in lock-down. Whether these technology application companies will be able to start charging once the crisis passes (i.e. will governments interfere, or consumers resist), or will increasingly adopt revenue models based on mining user data for third-party advertisers, remains to be seen.
  • The unexpected windfall of users may also expose architectural flaws in a technology, particularly in terms of scalability, security and privacy. The highest profile example is, perhaps, Zoom Video Communications, which has seen a 20-fold increase in daily online meeting participants to c200m in the first quarter of 2020 but has also admitted to inadequate security defences against hackers and exploiters of private data. Precedents in the technology industry suggest that corporates and governments are more sensitive to data insecurity than consumers (who appear to place greater value on utility of the application than loss of privacy).


Figure 5: Price performance of tech-telco bellwethers

Source: Bloomberg, Tellimer Research

Tourism and travel: leisure may survive better than business travel, emerging markets better than developed

The shift of commercial meetings to online virtual meetings likely persists: the resulting cost savings will become embedded. However, for leisure travel the post-crisis outlook is not so clear cut. For potential international tourists at every income level, the liberation from many months of quasi-quarantine may act as a catalyst for a resumption of travel; a ticking off of items on the bucket list at a much earlier age than is usual.

Greater restrictions and higher costs (visas and health screening in advance, more expensive airfares and hotels after the closure of the financially weakest) may reduce value across the industry until sufficient supply exits. In markets with more informal and flexible labour, the tourism industry may survive in better shape than in those markets with highly restrictive labour. All other things equal, that might point to relatively brighter prospects in the emerging markets and the US, compared to, for example, the EU.

Figure 6: Travel and tourism direct contribution to GDP (2020f, %)

Source: WTTC, WB, Tellimer Research


You can read more on how Covid-19 is reshaping the world in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.

Read more
Strategy Note / Global

Domestic politics in EM after Covid-19: Authoritarianism and inequality

  • Governments will impose more limits on liberal society, and relations between local and central governments will strain
  • Covid-19 is, to use tax terminology, regressive. The economic impact hits the poor harder.
  • This likely causes a lasting impact on inequality, with resulting negative implications.
Hasnain Malik @ Tellimer Research
6 May 2020
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In our latest look at the long-term impact of Covid-19, we focus on the implications for domestic politics in Emerging Markets. Unfortunately, we think many of the changes may be for the worse, with governments imposing greater controls on society, more strained relations between local and central governments, and widening inequality.

Authoritarianism: governments will impose more limits on liberal society

So far in the imposition of social distancing, travel restrictions, contact tracing and quarantine policies in the response to Covid-19, governments globally, whether in authoritarian or democratic regimes, have taken steps to limit individual behaviour. In many cases, emergency executive powers granted under constitutional rules have been invoked. The timeframe over which these emergency powers will be exercised is as ill-defined as the timeframe during which Covid-19 will remain a systemic threat.

Furthermore, the surveillance capabilities of modern communications technology (communication on an open internet network, location-pinpointing and widespread smartphone use) provides a mechanism for governments wishing to prioritise security over personal information privacy. In the same way that governments, authoritarian or democratic, can appeal to nationalism or populism over individual liberty in determining the social contract, they can appeal to security over individual liberty.

The Covid-19 crisis may act as a catalyst for more widespread occurrence of this surveillance, as citizens grow as used to governments using their private data as corporations (Facebook et al) do.

In the initial response to Covid-19, many pointed to a relative advantage that explicitly authoritarian governments, eg China and Vietnam, have in imposing draconian measures such as social distancing. But it is no coincidence that the executive leadership with authoritarian leanings in notionally democratic governments have used the Covid-19 as an opportunity to strengthen their powers under a constitutional framework, eg Hungary and Sri Lanka.

The control of information and the shaping of popular perception is a part of this discussion. One of the challenges in countering Covid-19 has been the availability of objectively verifiable data on the number of infections, on the nature of the virus itself (many weeks into the global spread, the Trump administration in the US was still downplaying its significance), on the appropriate responses (whether to wear face masks, how communicable is the virus, the concept of herd immunity, the effectiveness of lockdowns), and on the state of preparedness (many weeks into the global spread, the Trump administration was also overplaying the resilience of the US). Governments will seek to control narratives via all media even more in a post-coronavirus world, because their political legitimacy is tied to popular perception of how well they have prepared for and responded to crises. The sort of censorship of online media traditionally associated with China may be as likely to spread to countries that consider themselves highly democratic.

Decentralisation: Relations between local and central governments will strain

In the case of countries as far apart as the US and India, central (federal) governments have appeared to follow the local (state) government policy responses in, for example, imposing social distancing or procuring healthcare equipment. 

In multi-layered and multi-party political systems, relations between central and local government, particularly when there is significant devolution of sovereignty and both are not controlled by the same political party, may strain more often after the precedents set during the Covid-19 episode.

Greater inequality between citizens

The sudden economic stop brought about by policy responses to Covid-19 is, to use tax terminology, regressive. The economic impact on lower-income segments (who lack the liquid savings needed to sustain their consumption) has been proportionately much greater than on higher-income segments.

This is seen starkly when comparing the effectiveness of fiscal relief on informal segments of the workforce compared to formal (and is one of the reasons why many emerging markets, with large informal workforces, are reluctant to mothball their economies for long).

Hysteresis effects (the impact of shocks to parts of an economy can far outlast the duration of those shocks) manifest themselves particularly acutely in low income and informal workforce segments: the increased incidence of starvation in a sudden economic stop or the permanent loss of jobs.

The overall result is that a major shock, such as Covid-19, likely causes a lasting impact on inequality with the resulting negative implications (eg crime and insecurity, strain on welfare states, appeal of populist politicians, recruitment of disenfranchised members of society by terrorist or anarchic movements).

Table 1: Inequality (Gini Coefficient, zero = full equality)

Source: UN, WB, Tellimer Research

You can read more in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.

Read more
Strategy Note / Global

Active investing in EM equity after Covid-19: A final chance against passive

  • Outperformance of large EM index weights, China and Korea-Taiwan tech, in the Covid-19 crisis suits passive funds
  • But China disruption from economic fallout and worsening US relations might be a final chance for active funds to shine
  • Failure to reach critical mass, not passives, is the problem in FM. More of a private equity-type mandate is needed
Hasnain Malik @ Tellimer Research
25 May 2020
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As part of our look at the consequences of Covid-19, we focus here on institutional fund management in emerging market equities. Our view is that the disruption and dislocation of markets and business models may offer a last chance for active management in Emerging Markets, against the growing passive onslaught. For Frontier, the index may already be broken, and mandates which look more like private equity may be needed

Passive funds have been winning share from active funds for many years. In developed markets they now account for over half of the asset class. Drivers of this include lower fees, more sophisticated versions of passive (thematic passive funds), steadily rising markets, and the underperformance of the average actively managed fund.

And the rise of passive funds has made outperformance of actively-managed, bottom-up, fundamentally driven asset allocation more challenging, because the weight of passive flows – particularly when prompted by index changes – can overwhelm specific company or country investment cases and, all other things equal in a rising market and within a steady drop of inflows, the performance of passive funds can become somewhat self-fulfilling.

The vulnerability of passive funds should be greatest when there are major shifts in the backdrop of the market; breaks in the fundamental trends which have supported the largest components of an index. Passive funds have no defence against this, almost by design. 

Furthermore, the damage in performance can act as a reminder of the need to think longer-term, in terms of wealth creation; ie closer to the sort of time frame needed by successful, fundamentally-driven managers to achieve outperformance on the basis of a repeatable investment process.

So far the outperformance of China and Korea-Taiwan tech suggest passives will march on in EM

China and Korea-Taiwan Technology drive the majority of the weight in the EM equity index and EM traded value (liquidity). They also happen to be among the beneficiaries of China’s rapid emergence from Covid-19 disruption, the accelerated adoption of new technology across a range of services, and the gravitation of liquidity further into these dominant parts of EM during the current crisis. This should reinforce the outperformance of these largest index weights: all other things equal, this would suit passive fund strategies. 

Brazil, India, South Africa and Russia were already small relative to these markets and the likes of Saudi and Thailand were already too small to sway the performance of mainstream EM funds. The tail of irrelevant emerging equity markets (but sizeable countries and economies) for those benchmarked to the EM index has grown very long indeed.

But what if China on the cusp of one those major shifts to which passive strategies cannot easily respond?

However, we are sceptical that China can so easily recover (we find it incredible that infections, on official data, flatlined so early) and think that social distancing will reappear, that the shock to export demand has been felt fully, and that there will be lasting ripples in, for example, the shadow lending system, from the economic sudden stop. If this proves to be the case then this would equate to one of those periods when actively managed funds, positioned for this change in consensus view, could substantially outperform the passive comparators. 

Furthermore, the increasingly intense cold war between the US and China may present mainstream EM funds (both active and passive) with questions they have not faced before: will the weaponization of diplomatic, technology, territorial, and trade tools used by both sides in this cold war extend to capital markets and does that mean that, at some stage, there is a material risk that Chinese equities are deemed offside by US regulators? If so, that is not a question that passive strategies can easily take a view on in advance.

The challenge in Frontier and small EM has not been passives so much as failure to scale to critical mass

In Frontier Markets, the passive threat is much less advanced and should be much easier for active fund managers to defend against. A long list of factors suggest that actively managed strategies should outperform passive in small EM-FM: 

  1. Large swings in the country weights in indices such as MSCI FEM and MSCI FM (usually when a country is upgraded to EM) which drive disproportionate flows in and out of the stocks in those countries well in advance of the day those changes take effect.
  2. The loss of otherwise attractive investment cases at the stock level when that stock is removed from the index (eg as part of a country upgrade to EM).
  3. The high representation in indices of relatively mature companies or state-owned enterprises (which often do not have the most compelling investment cases).
  4. The extreme diversity of the investable universe (multiple geographies, languages, FX regimes, regulatory structures).
  5. High all-in trading costs (including commission, FX conversion, custodian, structured product access charges), and (vi) generally low trading liquidity (which inhibits the ability to easily trade in and out of stocks).

The biggest challenge for the small EM and FM asset class is that it has not yet reached a critical scale where asset allocators, as a whole, have to consider it and are drawn to individual funds by performance relative to a benchmark or peers alone. Instead the fate of a small EM and FM equity manager is perhaps much tougher; they need to substantially outperform DM and large EM and, ideally in more normalised environments, deliver positive absolute returns in US$ terms (regardless of DM and large EM performance).

FM may have to redefine itself as a quasi-private equity asset class, with much longer-lock up periods and the ability to invest in local currency and US$ sovereign bonds as well as public equity.

In the interim, small EM and FM equity markets likely return to being an almost entirely locally driven market where the catalyst for re-rating comes not, as it might have done in the past decade, from foreign investors but, rather, from local investors attracted to local equities when valuations relative to local bond yields and bank deposit rates become attractive.

Of course, for any small EM and FM fund able to withstand this crisis, the fruits of perseverance could be unrivalled; valuations are arguably attractive across the board (given the mainly strong balance sheets in every country’s bellwethers) and structural reform and growth themes should ultimately reassert. 

You can read more about how Covid-19 is reshaping the world in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.


Related reading

China and EM Tech valuation discount vs DM narrows ytd; not so for small EM-FM

Frontier-Emerging strategy: Benchmark, identity and confidence crises

7 reasons to consider investing in small EM and Frontier

Read more
Strategy Note / United States of America

US Dollar as reserve currency after Covid-19? A moot point for EM ex-China

  • Characteristics of a reserve currency are usually self-reinforcing, and therefore resistant to change
  • Potential challengers – Chinese Renminbi, or multinational, central bank-backed cryptocurrency – have their weaknesses
  • Ultimately, this discussion may be moot for emerging markets, with perhaps the exception of China
Hasnain Malik @ Tellimer Research
26 April 2020
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The US Dollar is still a very long way from being dethroned, and is again the safe haven of choice in crisis. But Covid-19 adds more pressure and raises the question of what we need from a reserve currency.

Characteristics, usually self-reinforcing, of a reserve currency

A reserve currency is usually defined as a foreign currency that is held by a country’s central bank in order to facilitate outbound investments, imports, and international debt repayments, as well as to manage that country’s exchange rate.

The role of the US Dollar (and predecessors such as UK Pound Sterling in the nineteenth century) as the dominant global reserve currency is based on a number of factors, many of which are mutually-reinforcing, or circular:

  • High share of the US economy in global economic activity (trade, investment, finance) although this share does not necessarily have to be dominant;
  • Full convertibility of the US Dollar and a liberalised capital account;
  • Stability, independence and the resulting international trust in the US central bank (the banking supervisory role and inflation control policies of the Federal Reserve) and US financial institutions (systemically important banks);
  • Confidence in the political legitimacy of the US government and the effectiveness of its institutions (rule of law and protection of property rights);
  • Dominant geopolitical influence (which can enforce, via the threat of sanctions, or encourage, via US Dollar-denominated trade access, investment and aid flows, the use of US Dollar); and
  • High incidence of invoicing of international trade in US Dollars and the widespread global perception of assets denominated in US Dollars as relatively safer.

Premature predictions of decline before

The decline of the US Dollar as a reserve currency that some predicted following the rise of the Euro, after the Global Financial Crisis, or even following the wider use of financial sanctions under the Trump administration, has not happened. The argument for that decline was predicated on three points.

  1. Other economies, like the Eurozone or China, would grow to a point where they rivalled or surpassed the US as a dominant global economic power and, in the case of China, the government has attempted to grow the international use of the Renminbi (eg in oil contracts).
  2. The US, in adopting unprecedented monetary easing following the Global Financial Crisis, was at risk of over-extending its “exorbitant privilege” (which refers to the unique ability of the US, because its currency is the global reserve currency, to avoid balance of payments pressure and to enjoy lower risk-free returns on US Dollar assets compared to risk-free returns on assets denominated in all other currencies). “Exorbitant privilege” was a phrase used in France, by politician Valery Giscard D’Estaing, after the establishment of the Bretton Woods system in 1944 of maintaining FX rates of the major currencies, including the US Dollar, to gold, at a time when the majority of gold reserves were controlled by the US.
  3. By restricting access of governments (eg Iran) and individuals (eg in Russia), deemed offside of US foreign policy, to their existing deposits and investments in the US and to the international US Dollar payment system, or, by reducing the sovereign immunity of foreign governments against litigation in the US courts (eg Saudi and JASTA), the US may discourage the ongoing perception of US Dollar denominated and US-domiciled assets as relatively safe for foreign citizens and governments.

There is now a reinvigorated debate over whether the Chinese Renminbi may challenge the US Dollar, based on forecasts of China’s ever-increasing share of global economic activity and geopolitical influence, particularly if the current crisis results in an acceleration of these trends.

Alternatively, there are some, such as former Bank of England governor Mark Carney, who were arguing, prior to Covid-19, that multinational, central bank-backed, cryptocurrency may emerge as a rival to the US Dollar. This argument is based on the need to release all of the excess savings stored by governments globally in the form of US Dollar foreign reserves in order to drive higher growth. (This sort of cryptocurrency should not be confused with the likes of Bitcoin, once described by the IMF chief economist Gita Gopinath as “neither a unit of account nor as a cheap transaction technology, but primarily as a highly risky store of value”.)

We acknowledge that pressure on long-standing systems, like the US Dollar as a global reserve currency, can build for many years and culminate in a rapid change. But given the sheer distance by which the US Dollar dominates other reserve currencies today and our view that Covid-19 is a universal risk for economic growth and governments, it still looks unlikely to us that, on the timeframe of at least the next five years, the US Dollar will be dethroned either by the Chinese Renminbi or by a cryptocurrency backed by multiple governments.

Chinese growth may continue to outpace that of the US, but share of the global economy is merely one of the drivers of global reserve currency status. International confidence in the institutions underpinning the Chinese economy and its currency may have been damaged by the timeliness and transparency of its disclosure of data related to Covid-19.

The post Covid-19 economic policy response may be another instance of an over-extension of “exorbitant privilege” by the US. However, in a global environment where almost every policy authority is doing “everything it takes” to counter the sudden-stop from Covid-19 it is difficult to label accommodative monetary and expansionist fiscal policy in the US as unique.

This matters for investors in emerging markets because currency risk is a major factor for growth and because most foreign institutional investors in EM have to generate superior returns in US Dollar terms than, often, US equities (which, of course, are in US Dollar terms).

A moot point for emerging markets, ex-China

Ultimately, this discussion may be moot for emerging markets, with perhaps the exception of China.

As long as the currencies of emerging markets (and the economies and institutions which underpin those currencies) are perceived as relatively riskier than the global reserve currency (whether that is the US Dollar, the Chinese Renminbi, or a new cryptocurrency backed by multiple governments) then those emerging markets will have to maintain a balance of reserves in the denomination of the global reserve currency.

Essentially, even if the US Dollar was de-throned, it would merely shift the denomination of FX reserves for most emerging markets. The imperfections of transmission of shocks from the underlying economy of the reserve currency (the US, China, or whichever collection of governments supported a future crypto-reserve currency) would persist.


Figure 1: Currency share of global allocated FX reserves (Q4 2019)

Source: IMF, Tellimer Research


Figure 2: Currency share of syndicated cross-border loans in EM and DM

Source: Brauning and Ivashina (2017), BIS, Tellimer Research

Figure 3: Currency share of global trade and invoicing

Source: Gopinath (2015) using a sample of countries equivalent to c60% of global trade, Tellimer

You can read more on how Covid-19 is reshaping the world in our recently published report Waiting on the World to Change, in which we explore how the current crisis will result in new normals for politics, macroeconomics, business models, and finance.

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Equity Analysis / Global

FM and EM banks: Opportunities in adversity

  • Covid-19: There are lessons to be learnt for the financial sector from the past, especially from the GFC
  • We look at the implications for the sector of the policymaker responses to the virus
  • There will be structural change. We examine which banks are best-placed to cope.
Rahul Shah @ Tellimer Research
3 April 2020
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In this detailed presentation (available to research subscribers), we examine how the global pandemic has affected the financial sector in emerging and frontier markets, looking in particular at:

  • Our key takeaways from the 2007-09 bear market
  • The current policymaker response
  • Changes seen so far to banking regulations
  • Where we see the main pressure on earnings arising
  • Which banks should be most resilient to the downturn, and over the cycle
  • Recent price performance, which has been driven more by liquidity than discrimination along fundamentals
  • The potential for certain banks to hedge portfolio FX risk
  • The outlook for portfolio positioning ahead of any market recovery
  • Potential winners from technology disruption
  • Our top picks in the sector 

Further details on some of these topics can also be found in the following recent reports:

FM and EM Banks: The 3-D threat from Coronavirus

FM and EM Banks: Where the rate-cut cycle hits hardest

How to hedge EM currency risk through bank equities

The future of payments: Could Covid-19 end cash’s reign?

Tech disruption in emerging markets and the battle for mobile payments supremacy

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