Emerging Economies’ Misinsurance Problem

Over the last decade, America’s expansionary monetary policy and China’s rapid GDP growth have been the two key drivers of global financial flows. Whether emerging economies are able to cope with the reversal of these dynamics will depend on whether they are sufficiently insured against domestic credit risks.

LONDON – Over the last decade, America’s expansionary monetary policy and China’s rapid growth have been the two key drivers of global financial flows. Now, both dynamics are being reversed, generating new risks for the global economy – particularly for emerging countries. Whether they can cope with these changes will depend on whether they have taken out enough insurance against the right risks.

Following the Asian financial crisis of the late 1990’s, emerging economies began to accumulate massive foreign-exchange reserves to protect themselves against the risks of external over-indebtedness. In fact, they amassed far more than they needed – $6.5 trillion, at last count – effectively becoming over-insured against external balance-of-payments shocks.

But they remained underinsured against domestic credit risks ­– the leading threat to emerging economies today. After the global financial crisis erupted in 2008, interest rates plummeted, fueling private-sector credit booms in many of the largest emerging markets, including Brazil, India, Indonesia, and Turkey.

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